Geopolitics and Markets: Middle East Tensions Continue to Reverberate
Escalating tensions between Israel and Iran have kept global markets on edge, with the situation evolving rapidly. Israel’s continued strikes on Iranian nuclear sites and strategic infrastructure initially had limited financial market impact outside of energy. However, following Iran’s retaliatory actions and a marked intensification of the conflict, risk sentiment deteriorated, culminating in a sharp end-of-week sell-off.
Oil prices have surged by approximately 12% since last week, reflecting both supply fears and broader geopolitical risk premiums. Equities declined by around 1% across most major indices, though resource-heavy markets, such as Canada’s TSX, experienced slightly smaller losses. Government bond yields in both Europe and the United States edged higher as investors reassessed risk exposure.
The Middle East conflict remains a dominant theme heading into the week. Markets are now highly sensitive to headlines, with even small developments triggering exaggerated price moves across energy, FX, and safe-haven assets.
Sterling Staggers as Sentiment Slumps
Sterling came under renewed pressure late last week, with GBP/EUR slipping to a four-week low after breaching key technical levels, while GBP/USD briefly touched a fresh three-year high at $1.3632 before retreating amid rising geopolitical anxiety and risk aversion.
The pound remains acutely sensitive to global sentiment. Investors have rotated into traditional havens such as the Swiss franc, Japanese yen, and gold, leaving sterling exposed. Meanwhile, the UK-US economic data gap has narrowed, making it harder for GBP/USD to gain traction above $1.36. Options markets are beginning to price in longer-term sterling weakness, reflecting concerns about domestic growth prospects and fiscal stability.
The Bank of England’s decision on Thursday will be closely watched. A hold on rates is expected, but the vote split and commentary will be key. Recent UK data, particularly around the labour market, has underwhelmed. As a result, markets have increased expectations for further BoE rate cuts this year, exerting downward pressure on short-term yields and the pound.
Until geopolitical risks ease, sterling is likely to remain under pressure as traders shy away from riskier exposures.
Euro Slips Amid Oil Surge and Growth Fears
The euro retreated to $1.15 after reaching a three-year high of $1.1630 the previous week. The shift came as markets digested the implications of surging oil prices and the broader fallout from Middle East instability. Europe, being a net energy importer, is particularly vulnerable to oil price shocks, which negatively impact its terms of trade.
Rising energy costs are also complicating the European Central Bank’s outlook. Lower inflation—previously supported by subdued energy prices—is now at risk of reversing, which, combined with persistent weakness in the manufacturing sector and fragile consumer and business sentiment, could push the Eurozone towards a stagflationary environment if the conflict endures.
Adding to these challenges, Eurozone industrial production for April registered its steepest monthly decline since July 2023, with broad-based sectoral weakness. This week, market attention will be on final Eurozone inflation data and the German ZEW survey, although geopolitical headlines will continue to dominate.
A de-escalation in Middle East tensions could revive euro demand, especially as fading demand for the dollar as a haven currency shifts flows back into the eurozone. But for now, cautious positioning prevails.
Dollar’s Tepid Rebound as Markets Stay Defensive
The dollar’s recent bounce has been modest, with haven demand fragmenting amid a complex web of geopolitical risk and monetary policy cross-currents. So far in 2025, the Swiss franc has captured the lion’s share of haven flows in the FX market, while gold has outperformed, reinforcing its status as the year’s leading defensive asset.
Last week ended with global sentiment fragile but orderly. Volatility spikes have led to periodic flights to safety, but investors have generally avoided outright panic, opting instead for risk reduction and balanced positioning.
This week could prove pivotal, with six G10 central bank meetings scheduled. The US Federal Reserve and the Bank of England are both expected to keep rates on hold, though the market still anticipates at least two Fed cuts before year-end. The Swiss National Bank may opt for a 50-basis-point cut to tame excessive franc strength, while Sweden’s Riksbank could ease by 25 basis points. Central banks in Norway and Japan are likely to remain on pause.
Economic data, including US sentiment indicators, retail sales, and industrial production, will offer further clues about the health of consumers and manufacturers. But with geopolitical tensions flaring and oil prices elevated, the overarching market tone remains defensive.
