Sterling traded lower on Tuesday as a rising dollar, supported by renewed military tensions in the Gulf, eclipsed domestic factors that looked broadly constructive for the UK economy. GBP/USD moved down to 1.3410, a drop of 0.19% on the session, while EUR/USD edged up to 1.1420, gaining 0.05% as of 07:20 ET (11:20 GMT).
The dollar received broad support as markets responded to an escalation of hostilities in the Gulf region. Brent crude climbed to $90 a barrel as investors increasingly priced in a sustained period of higher oil prices rather than a transitory spike. U.S. President Donald Trump has vowed retaliation against Iran after the deaths of three U.S. service members in Jordan, and Houthi militants have threatened a blockade of Saudi Arabia in the Red Sea.
"Dollar risks remain skewed to the upside today as markets continue to display a risky degree of complacency towards the military re-escalation," said Francesco Pesole, FX strategist at ING. He added that a move back to 101.50 in the DXY index would be consistent with the current environment.
The Federal Reserve is in its pre-meeting blackout period, leaving the U.S. data schedule light and providing little to counter the geopolitical-driven dollar bid. No Fed speakers were scheduled, and the market's next scheduled U.S. economic releases were listed as existing home sales on Wednesday and initial jobless claims on Thursday.
UK domestic data offered a mixed but overall constructive picture, which did not appear to be the main driver of sterling's movement. Wage growth slowed to 4.3% in the three months to May, slightly under expectations. The unemployment rate remained at 4.9%, and public borrowing fell to 3 billion in June, roughly one third lower than the prior year and below market forecasts.
Rather than the data, pressure on the pound stemmed mainly from the gilt market. Ten-year UK gilts underperformed their European counterparts after Prime Minister Andy Burnham signalled on his first day in office that he planned to exercise flexibility within the UK's fiscal rules. That guidance raised concerns among fixed-income investors and contributed to gilt underperformance.
Market uncertainty increased after a post-market surprise appointment of John Healey as Chancellor of the Exchequer, replacing the previously favoured Shabana Mahmood. The appointment added another layer of uncertainty, even though sterling's muted reaction suggested investors view Healey as broadly comparable to his predecessor in terms of market implications.
BofA Securities has moved to a neutral near-term view on sterling after EUR/GBP fell below 0.85 this week. Its rolling fair-value model placed GBP/USD near 1.33, implying sterling was "only modestly rich, by around 1-2%, rather than substantially overvalued."
EUR/USD remained just above the 1.140 level that ING had identified as a near-term test. Pesole said that rate differentials have offered support for the euro, but he expressed skepticism that European Central Bank rate expectations could shift much further from current levels; markets were pricing 44 basis points of easing by year-end. He noted that a break below 1.140 would put the next key support at 1.1330, the June low.
ING highlighted a recovery in the dollar index toward 101.50 as the principal near-term driver for markets. For GBP/USD to regain momentum, ING said gilt market stabilization would be necessary. More broadly, a de-escalation of Gulf tensions remains the central macro wildcard that could alter the current directional pressures on currencies.
BofA reiterated a year-end EUR/GBP forecast of 0.84 but cautioned that recent sterling gains may require a period of consolidation before further appreciation.
With the Fed silent in the blackout window and geopolitical risk elevated, currency markets remained sensitive to developments in both the Gulf and UK political landscape. The interplay between higher oil prices, shifting gilt dynamics and political appointments will likely remain focal points for traders until clearer signals emerge on either the geopolitical front or policy expectations in Europe and the U.S.