GBP/USD rallied modestly on Friday after rebounding from intraday lows, helped by improving risk sentiment on a potential US-Iran peace deal. At the time of writing, the pair is trading around 1.3460 and is on track to end the week with little changed.
A senior Iranian source told Reuters that “Iran and the United States have reached a political agreement, but it has not yet been finalized.” This followed reports that the two sides had reached a proposed 60-day Memorandum of Understanding (MOU) that would extend the current ceasefire and reopen the Strait of Hormuz.
Meanwhile, US President Donald Trump announced the lifting of the naval blockade in Iranian ports in a post on Truth Social. Trump also said Iran “must agree that it will never have a nuclear weapon or a bomb” and added that the Strait of Hormuz “must be opened immediately, without toll, to unrestricted shipping traffic in both directions.”
Cautious optimism pushed the US dollar (USD) lower, helping the British pound (GBP) recover some of the losses recorded earlier in the week. The U.S. Dollar Index (DXY), which tracks the dollar against a basket of six major currencies, is holding near 98.80 after hitting a seven-week high of 99.54 on Thursday.
Due to the latest developments, oil prices have also fallen. At the time of writing, West Texas Intermediate (WTI) is trading around $86 per barrel and heading for its first monthly decline in five months. However, oil prices remain well above pre-war levels, maintaining the risk of inflation.
Bank of England (BoE) Governor Andrew Bailey said earlier on Friday that “the softness of the economy and the uncertainty around the Iran war shock mean that temporarily tolerating above-target inflation is the right way to approach policy compromise.” He added that the central bank has already “tightened policy significantly” after taking expected interest rate cuts off the table in response to the shock to market expectations.
Kansas City Federal Reserve (Fed) President Jeff Schmid said policymakers “may need to consider how to make monetary policy more restrictive” and stressed that the Fed “must signal a commitment to lowering inflation.”
Looking ahead, next week investors will focus on global flash PMI data and the US jobs report, which includes nonfarm payrolls (NFP) data, the unemployment rate and wage growth.
Frequently asked questions about inflation
Inflation measures the augment in prices of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a monthly (m/m) and annual (y/y) basis. Core inflation excludes more volatile items such as food and fuel, which can fluctuate due to geopolitical and seasonal factors. Core inflation is the figure economists focus on, and it is the level aimed at by central banks, which are required to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (m/m) and year-on-year (y/y) basis. Core CPI is the figure that central banks target because it does not include variable spending on food and fuel. When core CPI rises above 2%, it typically results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
While it may seem counterintuitive, high inflation in a country causes the value of its currency to augment, and vice versa for lower inflation. This is because the central bank usually raises interest rates to combat higher inflation, which attracts more capital inflows from around the world from investors looking for a lucrative place to put their money.
Historically, gold was the asset that investors turned to in times of high inflation because it held its value, and while investors will often continue to buy gold for its safe and sound haven property in times of extreme market turmoil, in most cases this is not the case. This is because when inflation is high, central banks raise interest rates to combat it. Higher interest rates are bad for gold because they augment the opportunity cost of holding gold compared to interest-bearing assets or putting your money in a deposit account. On the other hand, lower inflation is usually good for gold because it lowers interest rates, making the dazzling metal a more viable investment alternative.
