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Pound-dollar rate can come under pressure in the coming days, but losses should be limited.
It's a soft start for pound sterling while the dollar is bid on Monday, as stocks trade lower and Brent crude oil prices jump 5% to $95 / barrel owing to a deterioration in the situation in the Middle East and fears a two-week ceasefire won't be extended.
The ceasefire is due to end Tuesday, but tensions are building after USS Spruance on Sunday opened fire on and ceased the Iranian-flagged Touska after it tried to break through a U.S. blockade in the Gulf of Oman.
U.S. and Iranian negotiators were due to hold talks in Pakistan on Monday, but Iran has said it won't attend owing to the U.S. seizure of the Iranian ship.
"The dollar has come back a little bid on more tough talk between the US and Iran, plus the US Navy's seizure of an Iranian cargo ship," says Chris Turner, head of FX analysis at ING.
Tuesday is an important day as the two-week ceasefire agreed between the U.S. and Iran expires and any resumption of the kinetic war materially raises risks for markets.
A key concern is that the longer oil prices stay elevated at current levels the more demand destruction we see in the global economy. With ex-U.S. growth most exposed to an elongated crisis, the dollar will naturally outperform in such an environment.
Further USD gains are possible in the coming week as the currency's safe-haven status shines.
GBP/USD gapped lower at the open, falling to 1.3480 graphical support before rebounding to 1.3498. The previous week's high is up at 1.36 resistance.
We look for a return to this level if the U.S. and Iran agree an extension to the ceasefire, which is something we would expect after the markets close tonight as we know Trump likes pushing his hand until the last minute before revealing the other side has given him what he wants.
We'd expect a drop through 1.3480 support in the event that no ceasefire extension is forthcoming and Trump pursues his latest threat made overnight:
"We’re offering a very fair and reasonable DEAL, and I hope they take it because, if they don’t, the United States is going to knock out every single Power Plant, and every single Bridge, in Iran. NO MORE MR. NICE GUY!"
USD strength will nevertheless be limited by a market that is more inclined to see the positives: USD is far more responsive to good news than bad news, meaning reactions to de-escalation are usually more significant than moments of escalation.
For the dollar, that implies periods of strength have tended to be limited relative to periods of weakness. For GBP/USD, that suggests limited downside potential ahead of another leg higher as the two sides inevitably come to a deal.
"Any wobble could be short-lived and an opportunity to re-establish dollar shorts," says a weekly FX note from Barclays.
Domestically, this week will also see traders take into account UK politics as the UK Prime Minister will account for himself in Parliament on Monday afternoon over the latest developments in the Mandelson affair.
We reported last week that the British pound's outlook had dimmed as a new political flare-up raises the odds that Starmer will be replaced by a fiscally incontinent left-winger.
On Tuesday, Sir Oliver Robbins will give his account to MPs on how the appointment of Mandelson as U.S. ambassador played out, which should offer further intrigue. Robins was fired last week for allegedly keeping secret that Mandelson had failed security vetting ahead of his appointment to the role.
Despite the piqued interest in UK politics it looks as though Starmer will survive this latest chapter in the Mandelson saga as there are no challengers waiting to take the top job and we suspect that's wise: there's an inflationary and cost of living crisis coming down the line. They are better served waiting.
We're also watching UK wage and employment data on Tuesday, although the impact should be muted due to the figures covering the pre-war period.
More interesting will be Wednesday's inflation prints as these will show the extent of the initial impact of the war. Surging fuel prices will come as no surprise, but we'll be interested to see if ex-fuel sectors of the economy raised prices.
If so, then there's a very real possibility that the UK faces another entrenched inflationary episode and the Bank raises interest rates in response.
That could offer the pound some support, although we'd be cautious of chasing it higher into a stagflationary episode of high inflation and low growth.