The Middle East situation and the selling pressure on British bonds led to the pound dropping to a three-week low.

On Wednesday, the pound fell to a three-week low against a strengthened dollar, as investors closely monitored the escalating conflict in the Middle East and renewed selling pressures in the UK bond market. That day, both the US and Iran returned to a state of war readiness following the most intense exchange of fire in weeks. UK bond yields hit an 18-year high, adding extra pressure ahead of Chancellor John Healeys first budget presentation on October 28. The pound against the dollar was reported at 1.3482, down 0.25%, marking the lowest level since August 14. The dollar index reached a two-week high, as investors turned to the dollar for safety amid growing concerns over energy shocks, while also weighing the divergent monetary policy paths of major economies. Healey will unveil his first budget on October 28 and has pledged to adhere to the borrowing rules set by former Chancellor Rachel Reeves. Matthew Ryan, market strategy director at Ebury, stated: The one-month implied volatility of the pound has fallen to its lowest level in over 12 years, but we expect this level to form a bottom in the short term due to the brewing tension ahead of the budget. He added, The rise in yields will directly erode the government's fiscal space, increasing the risk of tax hikes this autumn, even before accounting for any additional spending increases that Healey may pursue. The euro rose 0.10% against the pound, trading at 85.85 pence. The path of interest rates set by the Bank of England remains a background factor in the market. The market widely expects the Bank of England to keep rates unchanged at 3.75% this month, while pricing in a 25 basis point hike before the end of the year. Sanjay Raja, chief UK economist at Deutsche Bank, noted that while its baseline expectation remains to keep rates unchanged, he stated: The combination of rising inflation, increased household inflation expectations, and a stabilizing labor market reduces the necessity for a more accommodative policy stance. We believe the debate over whether rates remain sufficiently restrictive will intensify in the coming months.