CAPITALDIGEST MARKET REVIEW, 25/05/2026
May 25, 2026
POUND SOFTENS AS UK CONSUMERS CUT SPENDING, PUBLIC FINANCES WORSEN
The pound edged lower on Friday as uncertainty over the status of peace talks between the U.S. and Iran prompted investors to buy the dollar and after UK data for April showed retail sales fell by the most in nearly a year and Britain’s public finances deteriorated sharply. This week has brought mixed economic data, including a monthly report on the labour market that showed unemployment is on the rise and real pay growth is barely positive, given the impact of inflation stemming from the Iran war. Friday’s retail sales data showed sales volumes fell 1.3% month-on-month in April, the steepest drop in nearly a year and more than double the 0.6% decline economists had expected. Consumers are cutting back on fuel purchases and discretionary spending, as they contend with soaring energy bills and uncertainty over the war. “The soaring price at the pump has put pressure on households still fighting back from their last brush with scorching inflation,” Danni Hewson, AJ Bell’s head of financial analysis, said. “Initially, motorists rushed to fill up as the impact of the Iran war sent fuel prices higher, but as it became clear this was not going to be a short-lived spike, people have regulated their behaviour. Non-essential journeys have been pared back as consumers once again think hard about how they’re going to spend every penny,” she said. The pound was down 0.1% against the dollar on Friday to around $1.3420, but still set for a 0.7% gain this week. Sterling has shaken off some of the weakness triggered by a political crisis in Britain, where Prime Minister Keir Starmer is under pressure to quit following heavy losses for his ruling Labour party in local elections. Against the euro , the pound has performed more robustly, having gained nearly 1% this week. On Friday, the euro was roughly flat at 0.8646 pounds. A separate report on Friday showed Britain’s public finances had the biggest shortfall since the COVID-19 pandemic in April in what could be an early taste of the budget hit facing finance minister Rachel Reeves caused by the Iran war. Borrowing during the month was 25% higher than in April last year at 24.3 billion pounds ($32.63 billion), the second-highest borrowing for April on record, according to the report. A Reuters poll of economists had pointed to a 20.9 billion-pound deficit in April, the first month of the financial year. “This provides an early sign of the deterioration in the public finances that is inevitable over the coming quarters,” Ruth Gregory, deputy chief UK economist at Capital Economics, said.
DOLLAR NEAR SIX-WEEK HIGH AMID IRAN WAR JITTERS
The dollar held near six-week highs on Friday as traders weighed the prospects of a near-term deal to end the Middle East war and assessed whether the Federal Reserve would raise interest rates if inflation continued to accelerate. The United States has seen some progress towards a deal with Iran but more work is required, Secretary of State Marco Rubio said on Friday, while Iran’s foreign ministry spokesman said the two sides’ differences were deep and significant. Traders are increasingly concerned that ongoing energy disruptions will filter through to core consumer prices, potentially forcing a tighter monetary policy response. “The key question now, of course, is if the Fed is going to hold,” said Noel Dixon, global macro strategist at State Street. So far, inflation pressures feeding into the Fed’s preferred gauge — Personal Consumption Expenditures — have remained relatively contained, Dixon said, supporting the case for keeping rates steady. However, he cautioned that “the risk to my view is that Trump resumes attacks on Iran in an aggressive fashion. That could be a catalyst for greater interest rate volatility, and that could cause the Fed to panic and seriously consider a hike.” Fed funds futures traders are pricing in 50% odds of a rate hike by October. The University of Michigan’s Surveys of Consumers on Friday showed that U.S. consumer sentiment plunged to a record low in May as surging gasoline prices fueled anxiety over worsening affordability, while inflation expectations also rose. Fed Governor Christopher Waller, an influential voice in policymaking who until recently had advocated for lower interest rates, said on Friday the U.S. central bank should axe the “easing bias” from its policy statement and effectively open the door to a possible rate hike. Kevin Warsh was also sworn in as Fed leader on Friday. The dollar index , which measures the greenback against a basket of currencies including the yen and the euro, rose 0.04% to 99.24, with the euro down 0.06% at $1.1611. The pound strengthened 0.11% to $1.3444, having shrugged off data earlier that showed retail sales dropped by the most in nearly a year in April, as consumers felt the pinch of the inflationary effects of the Iran war. Growth concerns are also impacting currencies, with the U.S. seen having a stronger outlook than many peers. Australia, meanwhile, is grappling with jet fuel and diesel shortages that threaten to drag on key industries. Dixon warned that potential fallout, including layoffs, may be difficult to reconcile with current expectations for as many as three rate hikes this year.
STERLING STEADY BUT WEAK BUSINESS ACTIVITY DATA WEIGHS
The pound was steady against the dollar on Thursday as broader currency markets focused on developments in the Iran war, while traders digested some worse-than-expected surveys of British business activity. Sterling was flat at $1.3437. Against the euro, the pound was 0.13% higher at 86.42 . A survey on Thursday showed British companies suffering their most widespread drop in activity in more than a year due to the economic fallout from the Iran war and political uncertainty at home. Data company S&P Global’s preliminary UK Composite Purchasing Managers’ Index for May tumbled to 48.5, from 52.6 in April, its first sub-50.0 reading since April 2025 and far below the 51.6 median in a Reuters poll. A PMI below 50.0 indicates slowing activity. The figure overshadowed recent positive British data reads, including strong Q1 GDP figures last week and inflation figures on Wednesday. April’s CPI figures on Wednesday showed inflation came in at 2.8% in April, down from 3.3% in March and below economists’ expectations for a 3% reading. “It’s a case of what might have been for the UK,” said Henry Cook, senior economist at MUFG Bank. “In a different world, we’d be looking at that Q1 GDP number and saying this is a great platform for growth ahead, yesterday’s inflation number would have been potentially bang on target… we’d be looking at a couple of BoE rate cuts this year.” “That’s a different world,” he said, highlighting the ongoing closure of the Strait of Hormuz that has choked the global flow of oil and led to a surge in energy prices, upending central bank expectations and the global growth outlook. In April, the Bank of England kept interest rates on hold and assessed the potential economic impacts of the U.S.-Israeli war on Iran, one of which could necessitate a “forceful” increase in borrowing costs. Even so, money market bets indicate an 86% chance of no change at the BoE’s next meeting on June 18
DOLLAR WHIPSAWED BY CONFLICTING IRAN DEAL SIGNALS
The dollar index was flat on Thursday as traders weighed the likelihood of a near-term deal to end the Middle East war, having earlier touched a six-week high on doubts a breakthrough was close. The greenback had climbed after a Reuters report that Iran’s Supreme Leader issued a directive barring the export of the country’s near-weapons-grade uranium. It then surrendered those gains on unconfirmed reports that Washington and Tehran have agreed on a final draft of an agreement to end the war. President Donald Trump said the U.S. will eventually recover Iran’s stockpile of highly enriched uranium, which Washington believes is destined for a nuclear weapon, though Tehran says it is intended purely for peaceful purposes. Prolonged energy disruptions as the war drags on threaten to feed through to core U.S. consumer prices and inflation expectations, potentially pushing the Federal Reserve toward rate hikes. That has boosted the dollar, which is correlated to Treasury yields and also benefits from a safe-haven bid. A stronger U.S. growth outlook is adding further weight to the case for tightening and boosting the greenback, even as other economies around the world face a weaker trajectory and greater exposure to elevated energy costs. “We’re almost three months from the start of the oil shock and typically that’s when global growth starts to see a bit of a deterioration, so we’re a bit hesitant on global growth exposed currencies,” said Noah Buffam, director in FICC strategy at CIBC Capital Markets in Toronto.Weak PMIs in Europe, the UK and Japan on Thursday underscored that unease, boosting the dollar on the back of its comparatively stronger outlook. “A lot of them came in below expectations,” said Buffam. “Going forward we might see a little bit more growth weakness.” Economic activity in the euro zone shrank at its sharpest rate in more than 2-1/2 years in May, as a war-driven surge in living costs hammered demand for services and firms accelerated layoffs. Even so, rate hikes likely lie ahead, said Andrew Kenningham, chief Europe economist at Capital Economics. “There is nothing here to put the European Central Bank Governing Council off its plans to raise rates by 25 bps in June, nor anything to ease concerns about the risks of a recession,” Kenningham said. British companies are suffering their most widespread drop in activity in over a year, while Japan’s manufacturing sector slowed slightly in May and service sector growth ground to a halt for the first time in over a year.
POUND EDGES UP BUT POLITICS, INFLATION LIMIT GAINS
The pound rose on Monday, but remained just above its lowest since early April, which it hit earlier, as concern over a spike in inflation from rising energy prices collided with a political crisis in Britain. Prime Minister Keir Starmer is under intense pressure to quit after dismal local election results earlier in May, which has pushed up gilt yields sharply and weighed on the pound.The heavy losses for Labour in the May 7 elections triggered almost a quarter of his lawmakers to call for him to go, and two rivals are openly vying to replace him, unsettling investors who have the government’s borrowing costs. “I am focused on the job that I was asked to do, which is to serve my country and to carry out my duties as prime minister of this country,” he told staff during a visit to the Labour Party’s headquarters. Sterling was last up 0.4% on the day at $1.337, having fallen earlier by as much as 0.15% to $1.3304, its lowest since April 8. UK gilt yields surged to multi-year highs last week, as investors fret that a potential left-leaning successor to Starmer might be inclined to expand government borrowing to boost growth, which would hurt Britain’s already fragile finances. Higher yields usually act as a draw to foreign investors who are seeking better returns. But in this case, stagnant growth and the risk of a bigger inflation shock in the UK, given the country’s reliance on energy imports, have acted as a deterrent to holding the pound as well. “The unfavourable domestic political developments come at a challenging time for the gilt market which is also facing the risk of much higher inflation from the energy price shock,” MUFG currency strategists said. They said they currently favoured selling the pound to buy the lower-yielding Swiss franc in the near term. Money markets show traders expect the Bank of England will need to raise interest rates at least twice this year , having priced in the prospect of around two cuts before the Iran war broke out in late February.
