Pound Hits Three-Week Low as Middle East Tensions Escalate

The British pound hit a three-week low against the US dollar on Wednesday as investors kept a close eye on the escalating conflict in the Middle East and growing concerns about an energy shock. The UK government bond yields reached fresh 18-year highs, adding to the challenges facing Finance Minister John Healey ahead of his first budget on October 28.

The pound was down 0.05% to $1.3510, reaching its lowest level since August 14 at $1.3490. The US dollar hit a two-week high as investors turned to the currency amid growing concerns about the energy shock and diverging monetary policy paths across major economies.

Matthew Ryan, head of market strategy at Ebury, noted that one-month implied volatility in sterling has fallen to more than 12-year lows, but expects this to be a floor for some time due to brewing budget jitters. He also warned that the rise in yields will eat directly into the government's fiscal headroom, raising the risk of tax hikes in the autumn.

The euro fell 0.05% to 85.72 pence as investors weighed diverging monetary policy paths across major economies. The Bank of England rate path remained in the background with markets pricing in a quarter-point increase by the end of the year, but Sanjay Raja, chief UK economist at Deutsche Bank, believes that the debate around whether rates remain sufficiently restrictive will gather momentum in the coming months.