Dollar Toppled as Oil Shock Turns Central Banks Hawkish

Dollar Falls as Hawkish Central Banks Respond to Oil Shock Driven by Middle East Conflict

Global Currency and Interest Rate Movements Amid Middle East Tensions

By Jiaxing Li

HONG KONG, March 20 (Reuters) - The dollar slid from multi-month highs this week as soaring energy prices upended the outlook for global interest rates, with the U.S. Federal Reserve left alone as the only major central bank that is not expected to hike rates this year.

Impact of U.S.-Israeli War on Iran

Before the U.S.-Israeli war on Iran began at the end of February, investors expected two Fed rate cuts this year and now think even one is a distant prospect.

Major Currencies Gain Against the Dollar

The euro, yen, sterling, Swiss franc and Australian dollar were all set for weekly gains against the greenback as policymakers laid the groundwork for higher interest rates in response to war in the Middle East choking oil and gas supplies.

Performance of Key Currencies

The euro, marginally softer at $1.1569 in the Asia morning, is up 1.4% for the week. The yen, which steadied around 157.88, has gained 1.2% and sterling, hovering at $1.3422, is up a bit more than 1.5%.

Oil Price Surge and Its Effects

Benchmark Brent crude futures are up about 50% since the U.S. and Israel started their war on Iran last month, which has all but closed the sea lane for Middle East energy exports.

Central Bank Responses to Energy Price Shock

European Central Bank (ECB)

The European Central Bank kept rates on hold on Thursday but warned of inflation driven by energy prices and sources told Reuters policymakers are likely to start discussing hikes next month - a contrast with the Fed's wait-and-see approach.

Investors swept away expectations for a long hold on European rates at 2% to price in a hike by June.

Analyst Perspectives

"While the Fed is willing to display patience in the face of a shock generating two-sided risks to its mandate, the ECB seems unusually sensitive," analysts at J.P. Morgan said.

"There appears to be a genuine tilt towards a rate hike this year, even if it remains uncertain how quickly it will translate into action."

Bank of England (BoE)

The Bank of England kept rates on hold as well, but set off one of the sharpest ever routs in short-dated gilts by saying it was ready to act and markets, which had seen rates drifting lower, have priced 80 basis points of hikes by year's end.

Bank of Japan (BoJ)

Earlier on Thursday, the Bank of Japan left the door open to a hike as soon as April, wrongfooting investors who had bet on a further slide in the yen - and helping to lift the currency.

Reserve Bank of Australia (RBA)

The Australian dollar was trading just shy of 71 cents on Friday for a weekly gain of 1.5%, after the Reserve Bank of Australia hiked interest rates for the second time in as many months and investors expect there is more to come.

Market Reactions and Outlook

Crude Price Fluctuations

Crude prices dipped slightly on Friday after U.S. President Donald Trump told Israel not to repeat attacks on Iranian energy infrastructure, after a round of tit-for-tat strikes that left a Qatari gas plant crippled.

Federal Reserve's Position

The Fed left rates on hold, as expected, earlier this week but Chair Jerome Powell said it was too soon to know the scope and duration of any economic fallout from the war.

Dollar Index and Analyst Views

The dollar index was steady at 99.359, but was on track for a 1.1% weekly decline, its largest since late January. Still, many analysts think a prolonged decline is unlikely.

"The longer the war drags on, the higher the U.S. dollar will go, because it will benefit from safe-haven demand arising from higher uncertainty (and) also from the U.S. being an energy exporter," said Carol Kong, currency strategist at Commonwealth Bank of Australia.

(Reporting by Jiaxing Li in Hong Kong. Editing by Tom Westbrook and Thomas Derpinghaus)