Market overview

Brent’s sharp reversal, after briefly trading near $119/bbl before dropping back towards $107/bbl, helped improve risk sentiment and took some support away from the dollar. Reports suggesting progress towards restoring shipping through the Strait of Hormuz, together with hopes that the conflict may de-escalate more quickly than feared, encouraged that move.

Even so, oil remains the dominant macro input for FX. This week’s central bank meetings did little to change that. While the Fed retained a firm tone, the ECB and BoE delivered a more forceful hawkish signal than markets had anticipated, narrowing the dollar’s relative appeal. For now, rate expectations remain highly sensitive to commodity prices, and FX is likely to stay reactive to developments in energy markets and the Middle East.

USD: Fed firmness overshadowed by Europe’s hawkish shift

The dollar has softened as markets look through the Fed’s message and focus instead on the more pronounced repricing in Europe. Chair Powell struck a reasonably firm tone this week, but that was not enough to offset the impact of a hawkish ECB and an unexpectedly assertive BoE.

That said, the decline in USD also reflects a degree of optimism on the geopolitical front. Whether that extends further will depend on a clearer improvement in the security backdrop, particularly around the Strait of Hormuz. In the absence of firmer evidence of de-escalation, the dollar may yet find support again from renewed energy-driven risk aversion.

GBP: BoE surprises on the hawkish side

Sterling drew support from a notably hawkish BoE hold. The 9-0 vote was firmer than expected, with markets previously looking for two votes in favour of a cut. Even more strikingly, Swati Dhingra, usually seen as one of the Committee’s more dovish members, raised the prospect of higher rates if inflation pressures intensify.

The message was clear: the BoE stands ready to respond if energy prices feed into broader inflation. Markets reacted aggressively, pricing around 70bp of tightening by year-end, including roughly 50bp added after the meeting. We think that move looks too far for now, particularly given weaker second-round inflation risks than in 2022, but the repricing is still providing support for the pound.

Relative rate expectations have also helped keep EUR/GBP broadly steady, with most of the adjustment instead showing up in GBP/USD. For GBP/EUR, the market is again testing the 1.16 area, a level that has repeatedly capped gains over the past year. A clean break above it would strengthen the case for a move into the mid-1.16s.

EUR: An April move is no longer off the table

The ECB struck a cautious tone publicly, reflecting uncertainty around energy prices, but the overall message was firmer than it first appeared. President Lagarde acknowledged mounting upside inflation risks, and subsequent reporting suggested policymakers are already discussing the possibility of an April hike if price pressures intensify.

That matters. Until recently, markets saw June as the earliest realistic point for ECB tightening, on the view that policymakers would need time to assess second-round effects. Bringing April into the discussion suggests a greater willingness to move early and, if necessary, in consecutive steps. That materially strengthens the euro’s medium-term rate support.

We are not yet ready to fully endorse an April hike, particularly if energy prices fall back and geopolitical risks ease. But the probability of earlier ECB action has clearly risen. Near term, EUR/USD still looks somewhat rich given where oil and gas prices remain, and further gains will probably require a more convincing improvement in the energy backdrop. Still, with gas prices off their highs and ECB pricing turning more assertive, the euro now has firmer support underneath it.

Looking ahead

• Markets will remain highly sensitive to any headlines on de-escalation and shipping conditions in the Strait of Hormuz.

• Oil and gas price direction should continue to dominate FX more than central bank rhetoric.

• For USD, further downside likely requires clearer evidence that geopolitical risks are easing.

• For EUR, attention is on whether April rate hike pricing gains further traction.

• For GBP, the key question is whether markets have moved too far in pricing BoE tightening this year.

• A sustained break above 1.16 in GBP/EUR would be technically significant.