Dollar Weakens as Middle East War Reshapes Global Rate Expectations

The U.S. dollar retreated from multi-month highs this week as surging energy prices, triggered by the ongoing U.S.-Israeli military conflict with Iran, dramatically shifted global interest rate forecasts. The greenback is now under pressure as major central banks signal rate hikes while the Federal Reserve maintains a cautious, wait-and-see stance.

Since the conflict began in late February, Brent crude futures have surged nearly 50%, effectively choking off Middle Eastern energy exports and stoking inflation fears worldwide. Investors who once anticipated two Fed rate cuts in 2025 now consider even a single cut unlikely, leaving the dollar vulnerable against competing currencies.

The euro climbed 1.4% for the week to $1.1569, sterling rose over 1.5% to $1.3422, and the Japanese yen strengthened to around 157.88, gaining 1.2%. The Australian dollar also approached 71 cents, up 1.5% weekly, after the Reserve Bank of Australia raised interest rates for the second consecutive month. The Swiss franc similarly posted weekly gains against the dollar.

The European Central Bank held rates steady but strongly hinted at potential hikes as early as June, citing energy-driven inflation. The Bank of England echoed this hawkish tone, triggering one of the sharpest selloffs in short-dated gilts in recent memory, with markets now pricing in roughly 80 basis points of increases by year-end. Meanwhile, the Bank of Japan left the door open to hiking as soon as April, catching yen bears off guard.

Fed Chair Jerome Powell acknowledged uncertainty around the war's economic impact but offered no clear forward guidance, reinforcing the contrast with other central banks.

The dollar index slipped to 99.359, heading for a 1.1% weekly loss. Analysts warn, however, that a prolonged dollar decline is unlikely. As one strategist noted, a drawn-out conflict could ultimately boost the dollar through safe-haven demand and the United States' advantage as an energy-exporting nation.