Sterling registered a slight decline on Monday while the euro sustained gains against the dollar, as a pre-Federal Open Market Committee (FOMC) bid for the dollar counterbalanced a broader risk-on response to lower oil prices and a pause in recent Middle East hostilities.
At 07:46 ET (11:46 GMT) GBP/USD was quoted at $1.3316, down about 0.06%. EUR/USD was trading around $1.1390, up roughly 0.19%.
FX strategists at ING noted that, after a period of range-bound trading, EUR/USD had finally moved lower last week as markets grew more attentive to the recent escalation of tensions in the Middle East. The broker added that Brent crude had retreated to near $92 a barrel, attributing the drop in part to reporting that Iran and Oman were engaged in talks over the Strait of Hormuz and to a second consecutive day without fresh fighting between Iran and the United States.
"Last week, EUR/USD finally edged lower from its recent range as markets took the escalation in the Middle East more seriously," said Francesco Pesole, FX strategist at ING.
ING warned that even a modest uptick in geopolitical risk could push oil back above $100 a barrel, with the broker noting the possibility of prices reaching $120 per barrel should tensions flare again. The firm said that unless the current pause in hostilities proves durable and negotiations make clear progress, it expects further near-term dollar strength.
Markets are now closely focused on the Federal Reserve decision due on Wednesday, with policymakers widely expected to keep interest rates unchanged. ING highlighted concerns that Chairman Kevin Warsh's reluctance to use forward guidance could increase the chance of market surprises on the day of the announcement, a dynamic the strategist said could prompt precautionary dollar buying ahead of the FOMC.
Money markets, according to the data referenced by ING, are pricing about 8 basis points of easing at the meeting and roughly 41 basis points of easing by the end of the year. Meanwhile, Thursday's second-quarter US GDP release is expected to show annualised growth of 2.1%, unchanged from the first quarter, and June core personal consumption expenditures are forecast at 0.2% month-on-month.
ING assessed that sterling's recent weakness is not being driven by fresh UK fundamentals but rather by that wider pre-Fed dollar bid. The broker also pointed out that EUR/GBP has rebounded to about 1% above its 15 July low of 0.8455 and, based on valuation models, still looks undervalued.
Attention will shift to the Bank of England's policy decision on Thursday. Rates are forecast to be held at 3.75% in a 7-2 vote, according to the information cited, with Governor Catherine Mann possibly joining Huw Pill and Megan Greene in a dissenting minority that would favour a hike.
UK inflation slowed to 2.6% in June, marking a 15-month low and coming in below the Bank of England's forecasts. ING said this data point contributes to the view that markets may repricing toward dovishness for sterling, noting that markets are pricing about 38 basis points of tightening by year-end and that a dovish shift remains the clearest near-term risk for the pound.
On the euro, ING suggested caution despite Monday's price moves. EUR/USD regained levels above 1.140 as oil prices fell sharply, but the strategist cautioned that this recovery could be optimistic in the absence of a clear de-escalation path. ING warned that renewed strikes or an escalation could push EUR/USD back below 1.1380.
Energy market conditions remain a headwind for the eurozone. Dutch TTF gas benchmark prices were cited at about 58 per megawatt-hour, more than 30% higher than early-July levels, a development that continues to weigh on the eurozone's terms of trade. Eurozone consumer price index data due on Friday is expected to print above 3% year-on-year, with core inflation near 2.5%; money markets are pricing roughly 42 basis points of additional European Central Bank tightening by year-end.
ING concluded that a sustained easing of tensions in the Middle East, together with confirmation of a hawkish yet holding Fed, would be necessary to materially alter its near-term bias in favour of the dollar.
As central bank decisions and key economic releases converge this week, currency markets remain sensitive to shifts in geopolitical risk, oil prices and signals from policymakers. With multiple potential drivers and limited clarity on the durability of current developments, traders continue to position for a mix of precautionary dollar demand and the possibility of renewed risk-on moves if tensions ease further.