EUR/GBP edges higher as Middle East tensions lift volatility, UK politics in focus

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EUR/GBP edges higher on Monday as ongoing tensions in the Middle East keep market volatility elevated, while political uncertainty in the UK adds modest pressure on the British Pound (GBP). At the time of writing, the cross is trading around 0.8645, recovering from an intraday low of 0.8629.

EUR/GBP ticks higher as geopolitical tensions drive volatility.
Energy shock risks from Strait of Hormuz disruptions continue to weigh on the Euro.
Political uncertainty ahead of the UK local elections adds another layer of focus for traders.

A fire was reported at a petroleum site in Fujairah, UAE, after a drone attack from Iran earlier in the day. In a separate development, Iran’s Fars news agency reported that two missiles struck a US naval vessel near the island of Jask after it allegedly ignored warnings from the Islamic Revolutionary Guard Corps (IRGC) to halt. However, a US official denied that any American vessel had been hit, according to Axios.

However, the cross remains under steady downside pressure since the onset of the US-Iran war and the resulting disruption of flows through the Strait of Hormuz, a key chokepoint that carries around 20% of global Oil supply. While both the UK and the Eurozone rely heavily on imported energy, the UK is relatively less dependent than the Eurozone, leaving the Pound less exposed to the impact of rising energy prices.

Meanwhile, traders are also favoring the Pound over the Euro (EUR) on expectations that interest rate differentials between the Bank of England (BoE) and the European Central Bank (ECB) could widen further. Rising Oil-driven inflation risks are adding to this divergence. The UK continues to grapple with persistent inflation, which remains well above the BoE’s 2% target, while recent data show that price pressure is also picking up in the Eurozone, though it remains relatively more contained than in the UK.

This suggests the BoE may be forced to tighten policy if the inflation outlook deteriorates, whereas the ECB is likely to remain more cautious. The Eurozone’s higher exposure to energy shocks could weigh on growth, limiting the central bank’s ability to raise rates aggressively. Markets are currently pricing in at least two rate hikes from both central banks, though the path ahead remains highly dependent on incoming data and energy price dynamics.

Against this backdrop, EUR/GBP is likely to maintain a downside bias in the near term, with markets continuing to monitor developments in the US–Iran conflict, particularly any signs of a reopening of the Strait of Hormuz.

Attention is also turning to the UK’s local elections on May 7, with polls pointing to potential losses for Prime Minister Keir Starmer’s Labour Party. A leadership contest can be triggered if the leader resigns or if a challenger secures the backing of at least 20% of Labour MPs.

Inflation FAQs

What is inflation?

Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.

What is the Consumer Price Index (CPI)?

The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.

What is the impact of inflation on foreign exchange?

Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.

How does inflation influence the price of Gold?

Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.