Dollar wavers as Middle East conflict, inflation keep markets focused on rates

SINGAPORE: The US dollar traded in a narrow range on Thursday as investors weighed the impact of renewed US-Iran hostilities and persistent inflation pressures on the outlook for global interest rates.

The dollar index, which tracks the greenback against six major currencies, eased to 99.903 after the US military said it had carried out strikes on multiple targets in Iran. The move came after President Donald Trump warned that the United States could launch further attacks if a peace agreement is not reached.

The latest escalation has weakened hopes of a near-term resolution to the Middle East conflict and pushed oil prices higher, although currency market reactions remained relatively subdued compared with earlier phases of the crisis.

Analysts said markets were struggling to determine whether the conflict and disruption to regional trade routes, including the Strait of Hormuz, would become a prolonged feature of the global landscape or eventually lead to renewed negotiations.

The euro rose to $1.1547, recovering further from the 10-week low touched last week, while sterling traded at $1.3379.

The Japanese yen stood at 160.52 per dollar, keeping investors alert to the possibility of intervention by Japanese authorities. The Australian dollar traded at $0.7007 after earlier touching a nine-week low.

Investor attention also remained focused on monetary policy after data showed US consumer prices increased 4.2% in the 12 months to May, the highest annual rate since April 2023. The rise was largely linked to higher energy prices resulting from the Middle East conflict.

However, underlying inflation pressures showed some moderation. Core consumer prices, which exclude volatile food and energy costs, rose 0.2% in May after increasing 0.4% in April.

While economists believe the threshold for further monetary tightening remains high, traders have fully priced in a 25-basis-point Federal Reserve rate increase by December. The shift marks a sharp reversal from expectations earlier this year, when markets were anticipating two rate cuts before the Iran conflict escalated in late February.

The Federal Reserve is widely expected to leave interest rates unchanged at next week's policy meeting, which will be the first under Chair Kevin Warsh. A Reuters poll showed a strong majority of economists expect the central bank to keep rates unchanged for the remainder of 2026.

Market participants will closely watch Warsh's comments for signals on the inflation outlook and future policy direction. Analysts said investors would want reassurance that inflation remains a priority for the Federal Reserve even if further rate increases are not imminent.

Attention is also turning to the European Central Bank, which is expected to raise interest rates later on Thursday as inflation in the 20-member currency bloc remains above 3%, significantly higher than the ECB's 2% target.

However, uncertainty remains over the pace of future tightening. While financial markets are pricing in additional increases, economists remain divided because of weak economic growth across the region.

In Japan, Bank of Japan Governor Kazuo Ueda has been hospitalised for medical treatment and will miss the central bank's June 15-16 policy meeting. Despite his absence, markets continue to expect the Bank of Japan to proceed with a widely anticipated rate increase next week.

The combination of geopolitical tensions, elevated inflation and diverging central bank policies has left currency markets searching for direction, with investors awaiting fresh signals from major policymakers in the coming days.