Middle East tensions and UK bond sell-off pressure push the pound to a three-week low

According to Zhihui Finance APP, on Wednesday, the pound fell to a three-week low against the strengthening dollar as investors closely watched the escalating conflict in the Middle East and renewed selling pressure in the UK government bond market. On the same day, both the US and Iran returned to a state of war readiness after the most intense exchanges in weeks.

UK government bond yields reached an 18-year high, adding extra pressure on Chancellor John Healey before he submits his first budget on October 28.

The pound traded at 1.3482 against the dollar, down 0.25%, the lowest level since August 14. The US Dollar Index hit a two-week high as investors turned to the dollar as a safe haven amid mounting concerns over energy shocks, while also weighing the diverging monetary policy paths of major economies.

Healey will unveil his first budget on October 28 and has pledged to adhere to the borrowing rules set by his predecessor, Rachel Reeves.

Matthew Ryan, Head of Market Strategy at Ebury, said: “The one-month implied volatility of the pound has dropped to its lowest level in more than 12 years, but we expect this level to form a short-term base as tensions mount ahead of the budget.”

He added: “This rise in yields will directly erode the fiscal space available to the government, increasing the risk of tax rises this autumn, even before factoring in any potential additional spending increases Healey seems likely to implement.”

The euro rose 0.10% against the pound to 85.85 pence.

The Bank of England’s rate path remains a market backdrop. Markets widely expect the Bank of England to keep rates unchanged at 3.75% this month, while a 25 basis point hike by the end of the year has been priced in.

Sanjay Raja, Chief UK Economist at Deutsche Bank, after noting his baseline expectation remains for rates to be kept unchanged, stated: “The combination of rising inflation, household inflation expectations moving higher, and a stabilising labour market have reduced the need to ease policy. We believe that the debate about whether rates remain sufficiently restrictive will heat up over the coming months.”