Sterling Drops Along With Bonds as Iran War Shakes UK Markets

Sterling Drops and Bonds Tumble as Iran War Sends Shockwaves Through UK Markets

By Harry Robertson

Market Reactions to the Iran War and Impact on UK Financial Instruments

LONDON, March 23 (Reuters) - The pound slid against the dollar on Monday as investors flocked to the U.S. currency amid a selloff in global stocks, even while bond yields jumped as traders priced in four interest rate hikes from the Bank of England this year.

Bond Yields Surge Amid Inflation Fears

British 10-year Gilt yields rose to 5.079%, their highest level since 2008, as markets braced for a response to a potential inflationary shock from the Iran war. Yields rise as prices fall and vice versa.

Sterling Performance Against Major Currencies

Sterling fell 0.47% against the dollar to $1.328. 

The pound rose 0.9% against the U.S. currency last week as investors bet the UK's reliance on energy imports would force the BoE to push interest rates above those of the Federal Reserve, boosting the relative appeal of the pound.

Safe-Haven Flows and Central Bank Policy Expectations

However, the dollar rallied on Monday as global stocks tumbled and investors moved into safe-haven assets, and as investors also started to contemplate a potential Fed rate hike.

"Our sense is that yields have risen past the point where further increases are likely to be constructive for the pound," said Nick Rees, head of macro research at Monex Europe. 

He cited "downside implications for growth, and the adverse impact this will have on already stretched public finances".

Euro and Pound Dynamics Amid BoE Rate Hike Expectations

The euro was last down 0.1% against the pound at 86.64 pence as investors priced in four rate hikes from the BoE in 2026 - a dramatic reversal from the two cuts that were expected this year as recently as late February.

"Since the start of the conflict, the pound has held up relatively well," said Jane Foley, senior FX strategist at Rabobank. "We attribute this to the sharp turnaround in expectations regarding BoE policy."

Historical Context: Lessons from the 2022 Mini-Budget Crisis

Yet Foley said the 2022 Liz Truss "mini budget" crisis showed that the pound can be vulnerable if longer-dated UK bonds tumbled.

The pound slid to a record low of $1.033 while Gilt yields surged during that episode as investors dumped UK assets.

Foley said she sees the risk that the pound slips to $1.32 in the coming weeks and that the euro could rise against sterling in the medium term.

Government Response to the Energy Shock

British Prime Minister Keir Starmer is set to hold an emergency meeting with senior ministers and BoE Governor Andrew Bailey later on Monday to discuss the response to the energy shock stemming from the war.

(Reporting by Harry Robertson in London; Editing by Sharon Singleton)