Sterling muscled toward two-month lows by robust dollar

By Amanda Cooper

LONDON, June 8 (Reuters) - The pound neared its lowest level in nearly two months on Monday, largely because of the strength of the dollar, which benefitted from mounting expectations for U.S. rates to rise this year and from a degree of safe-haven demand, as violence spread across the Middle East.

Oil prices jumped as much as 5% after Israel said it hit an Iranian petrochemical plant, along with strikes elsewhere on military targets, despite U.S. President Donald Trump warning Israeli Prime Minister Benjamin Netanyahu to refrain from additional attacks. This kept capital flowing into the dollar, which was already around its highest point in two months against a basket of major currencies after a better-than-expected jobs report on Friday.

Sterling was steady at $1.334, just above the May 18 trough at $1.3304, the lowest point since April 8. Against the euro, the pound has fared a little better. So far this month, the euro has dipped 0.2% against sterling to around 0.864 pounds on Monday, but has remained in a fairly tight trading range over the past few weeks. 

The pound is now nearly 2% below where it was before the U.S.-Israeli war on Iran kicked off in late February. Throughout April, it gradually clawed back those losses, only to release them gradually over the four weeks that followed, as investors grew more unnerved about the possible impact on the global economy of higher oil prices and disrupted supply chains, which pushed them to favour the dollar. 

The other game changer for the pound has been the shift in rate expectations. With Britain more exposed to imported energy inflation than the U.S., traders had priced in the possibility of the Bank of England raising interest rates a couple of times this year before they factored in the chances of the Federal Reserve switching to hikes from cuts. This hypothetical advantage for the pound collapsed once the prospect of a U.S. rate rise came into play and traders focussed on the possible pain for the British economy from higher rates and higher inflation. 

As things stand, money markets show traders believe British rates could end the year at around 4.26%, compared with 3.75% now, while U.S. rates could wind up at 3.92% from a range of 3.5% to 3.75%.

A BoE survey on Friday showed British businesses expect to increase prices less quickly in the year ahead than they did in April as some of the initial energy price shock caused by the Iran war fades. This helped cement the view that the BoE might not raise rates until at least September.

"In theory, EUR/GBP should be trading higher if the BoE is dragging its feet on tightening at a time when the ECB is about to hike and the data is prompting a rethink on the Fed's position," ING strategist Chris Turner said in a note. "Equally, sterling is generally seen as a pro-risk currency with a large financial sector, meaning that it generally underperforms in a risk-off environment." 

(Reporting by Amanda Cooper; Editing by Thomas Derpinghaus)