The pound declined sharply on Monday as global markets reacted to escalating tensions in the Middle East, prompting investors to quickly adjust their expectations for higher interest rates.
Sterling fell by 0.5% against the dollar, dropping below $1.33, as the US currency strengthened due to a flight to safety.
The dollar index, which measures the greenback against a basket of major currencies, increased by 0.3%.
This sell-off occurred as traders significantly revised their outlook for the Bank of England, now anticipating as many as four quarter-point rate hikes this year. Just weeks ago, the market had expected two interest rate cuts.
This sudden shift reflects rising fears that the conflict involving Iran, the United States, and Israel could lead to a new surge in inflation driven by higher energy prices. Central to this crisis is the Strait of Hormuz, through which approximately one-fifth of global oil and liquefied natural gas supplies flow. Disruption of this route raises the possibility of a renewed energy shock.
Over the weekend, Donald Trump issued a 48-hour ultimatum for Tehran to allow shipping to resume, intensifying concerns about a wider conflict. He later agreed to postpone potential military action after discussions, but markets remain tense.
Keir Starmer held a 20-minute call with Trump overnight, with the crisis dominating their conversation as Western leaders scramble to stabilise global trade flows.
Rising oil and gas prices are already contributing to inflation expectations, potentially prolonging the cost-of-living squeeze and forcing central banks to maintain higher borrowing costs for longer.
For the UK, the effects are twofold: a weaker pound raises import costs, while higher interest rates risk putting additional strain on households and businesses. This sharp shift in market sentiment highlights how quickly geopolitical shocks can impact financial markets, revealing just how fragile expectations for lower rates had become.
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