Dollar strengthens as oil prices rise amid escalating Iran conflict

The U.S. dollar firmed on Friday, underpinned by worries that the Iran war could lead to an energy-driven inflation spike.

By 05:26 ET (09:26 GMT), the U.S. dollar index, which tracks the greenback against a basket of currency pairs, had risen by 0.4% to 100.13. The euro weakened against the dollar by 0.5% to $1.1459, while the British pound softened 0.5% to $1.3275.

"The dollar is pushing to new highs for the month as the market struggles to see a way out of the Middle East crisis," analysts at ING said in a note.

Now well over a week old, the joint U.S.-Israeli assault on Iran has shown few signs of waning, with President Donald Trump saying Washington is "totally destroying" Iran’s military and economy.

But Tehran has indicated that it will continue to fight. New Iranian Supreme Leader Mojtaba Khamenei has particularly said that the critical Strait of Hormuz waterway, through which a fifth of the world’s oil flows, will remain closed.

The prospect of a prolonged shuttering of the strait has sparked wild volatility in Brent crude prices this week. At one point, the global benchmark had soared to as high as almost $120 a barrels, before later retreating briefly below $90 a barrel. On Friday, Brent crude futures were hovering above $100 a barrel.

Much of the oil and gas passing through the Strait of Hormuz is used in a range of products, such as fertilizer and plastics, meaning that the sudden uptick in their prices could lead to heavy inflationary pressures in economies around the world.

These fears may translate into central banks, including the Federal Reserve, reconsidering possible interest rate cuts in the near-term. Higher borrowing costs may attract more foreign investment, bolstering the appeal of the U.S. dollar.

PCE data in focus

More detail could come to the inflation picture in the U.S. on Friday, when the personal consumption expenditures price index for January is due out.

Stripping out volatile items like food and fuel, the so-called "core" PCE gauge is seen coming in at 3.1% in the twelve months to January, slightly faster than 3.0% in December. The measure is closely monitored by financial markets, as it is one of the preferred metrics used by the Fed when determining monetary policy.

Since hitting a low point of 2.6% last summer, the core PCE index has been trending away from the Fed’s 2% target, the ING analysts said.

"This limits the ability of the Fed to cut rates this year, and we will hear a lot more from the Fed at next Wednesday’s FOMC meeting," they wrote.

Curiously, the Commerce Department’s PCE readings have recently been hotter than separate official consumer price index growth from the Labor Department, primarily driven by different weighting methods for housing and healthcare, alongside variations in scope and consumer substitution factors. Specifically, the lower weighting of cooling shelter costs in the PCE and higher exposure to rising medical costs have caused the PCE to remain more elevated than CPI.