The euro and the British pound have recovered all the ground they lost against the U.S. dollar after the recent Middle East conflict, supported by falling European energy prices and stronger-than-expected U.K. growth.
Fresh data showed the U.K. economy expanded 0.5% month-on-month in February, its fastest pace since April last year and well above earlier expectations, reinforcing support for the pound.
Safe-haven demand for dollar eases
Analyst Hardman said fading energy price risks have underpinned both the euro and the pound, while reduced demand for safe-haven assets has eased the earlier rush into the dollar during the height of geopolitical tension.
He noted that lower energy costs signal rising optimism that supply disruptions could ease if a peace agreement in the region is reached, helping both European currencies stabilize after their initial conflict-driven declines.
Central banks signal tighter policy
Policymakers at the Bank of England and the European Central Bank have kept an assertive tone, indicating they remain prepared to raise interest rates in response to earlier energy-driven inflation.
In contrast, officials at the U.S. Federal Reserve have indicated a greater willingness to accept higher inflation in the near term, widening the policy gap between the major central banks.
Hardman said both the Bank of England and the ECB are now reassessing the timing of any further monetary tightening as they gauge the lingering impact of past energy price spikes. Current projections still point to around 50 basis points of additional tightening from the ECB, though this is not expected before June or July, potentially capping near-term gains for the euro.
Euro area inflation picks up again
The policy divergence is sharpening as euro area inflation accelerates. The region’s annual inflation rate for March was revised up to 2.6%, from 1.9% in February, the highest reading since July 2024.
This persistence in price pressures is keeping the ECB’s governing council focused on further tightening, even as some members warn that higher rates could weigh on already fragile growth across the bloc.
Energy prices ease threat to European growth
The broader European outlook has been helped by a continued slide in wholesale gas prices. Dutch TTF natural gas futures fell again, closing near €42 per megawatt-hour, easing one of the most significant threats hanging over the continent’s economy in recent months.
Lower energy costs reduce pressure on households and industry, supporting consumption and production, and reinforcing the recovery in the euro and the pound.
Strong UK data backs hawkish Bank of England stance
The U.K.’s 0.5% monthly expansion in February provides the Bank of England’s monetary policy committee with further justification to maintain its firm stance on inflation.
Market expectations have shifted notably since the start of the year, moving from bets on imminent rate cuts to pricing in at least one additional rate hike. This repricing has strengthened the pound’s appeal versus the dollar and the euro.
Fed faces softer inflation backdrop
Across the Atlantic, the inflation backdrop looks different. The Fed’s preferred gauge, the core personal consumption expenditures price index, slowed to 3.0% year-on-year in February, reinforcing the case for a more patient approach to further tightening, or even eventual easing.
This softer inflation trend contrasts with the renewed inflation pressures in the euro area and the resilience seen in the U.K., helping define a clearer divergence in expected rate paths.
Capital flows and currency outlook
With the interest rate outlook between the three regions moving further apart, the stage is being set for capital to flow toward currencies tied to higher expected returns, raising the prospect of more persistent directional moves in foreign exchange markets.
Upcoming releases on inflation and labor markets from the U.S., U.K. and euro area will be watched closely. Any data that challenges current assumptions on growth or prices could trigger sudden and sharp repricing across currencies, bonds and equities, as traders adjust to a new view on where rates are headed.
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