Sterling sinks for third day as oil crisis burnishes dollar

Sterling Drops for Third Straight Day as Oil Crisis Boosts Dollar Demand

Market Reactions to Energy Price Surge and Geopolitical Tensions

By Amanda Cooper

LONDON, March 12 (Reuters) - The pound headed for a third daily loss against the dollar on Thursday, as concern about a lasting rise in energy prices and nervousness about the war in the Middle East drove investors into the dollar.

Central Bank Developments

Bank of England Governor Andrew Bailey was due to speak later on Thursday, a week before the central bank's rate-setting meeting.

Impact of Energy Prices on Currencies

As oil and natural gas prices have surged, so have investor expectations for inflation. Sterling, which has fallen by just 0.7% since the outbreak of the war on February 28, is one of the better-performing currencies among those belonging to economies that rely heavily on imported energy. [O/R]

The euro and the Korean won have lost 2% to 3%, while the Indian rupee and Japanese yen have lost more than 1.5% each.

Comparative Performance of Major Currencies

Highlighting the heavier fire for the single European currency is the euro's 1.3% drop against the pound since the start of the conflict.

The pound was last down 0.2% on the day against the dollar at $1.3386 and weakened against the euro, which rose 0.1% to 86.3 pence.

Rate Expectations and Bond Market Volatility

Shifting Interest Rate Outlook

RATE EXPECTATIONS SHIFT WILDLY

Typically, higher bond yields and the prospect of higher interest rates tend to support currencies, which may have cushioned the pound, to an extent.

Money markets have swung wildly in the last two weeks. Traders' assumption at the end of February was for the Bank of England to deliver two interest-rate cuts this year. That has now flipped to a near-50% chance for one hike by December.

The European Central Bank could raise rates twice this year, based on swaps market pricing, while the Federal Reserve looks less likely to deliver the two cuts markets had widely expected previously.

Expert Commentary

"The aggressive repricing of BoE rate-cut expectations is providing some support to sterling," City Index strategist Fiona Cincotta said.

"For now, the focus will remain on geopolitical developments and concerns over the war-driven surge in energy prices and inflationary pressures," she said.

Bond Market Responses

As investors have increasingly leaned towards a number of major central banks raising rates rather than cutting them, or leaving them on hold, they have sold short-dated bonds, which tend to benefit from stable, or falling, rates.

British gilts have been the hardest hit among the big bond markets, with 2-year gilt yields rising 50 basis points since the start of the war, compared with a roughly 38-bp rise in Italian yields, a 30-bp rise in Australian yields and just a 21-bp increase in 2-year Treasury yields.  

(Reporting by Amanda Cooper; Editing by Alex Richardson)