Dollar on track for second weekly loss in row.. Euro, Sterling hover near pre-war levels

The U.S. dollar headed toward its second consecutive weekly decline on Friday, while both the euro and the British pound stabilized near pre-war levels. Investors continued to scale back their safe-haven positions, driven by optimism over the Israel-Lebanon ceasefire and the potential resumption of talks with Iran.

A 10-day ceasefire between Israel and Lebanon went into effect on Thursday. Meanwhile, U.S. President Donald Trump indicated that the next meeting between the United States and Iran could take place over the weekend.

At the same time, American and Iranian negotiators have lowered their ambitions for a comprehensive peace agreement, shifting instead toward an interim memorandum to prevent a renewal of the conflict, as the nuclear file remains a major obstacle.

The dollar index, which measures the American currency against a basket of six major peers, edged down by 0.02% to 98.185. It is on track for a second week of losses, having surrendered most of its war-driven gains as de-escalation optimism eroded demand for safe havens.

Michalis Rousakis, a foreign exchange strategist at Bank of America, noted that “markets are relatively calm... the focus is on the possibility of extending the ceasefire, or even reaching a permanent one... our view on the dollar for the year remains negative, but we are cautious in the near term.”

In contrast, the euro stabilized at $1.178225, heading toward its third consecutive weekly gain.

Rousakis added: “Euro-dollar has currently returned to the levels it was at before the Iran war, even though energy prices are much higher now, suggesting that markets may have jumped the gun slightly.”

He noted that Bank of America's commodities team expects energy prices to normalize over time, but this could take several months, adding that “energy prices staying at these levels is not consistent with the euro trading at $1.18.”

Meanwhile, the British pound stabilized at $1.35225, despite renewed political pressure on Prime Minister Keir Starmer and calls for his resignation from opponents following revelations that his former ambassador to the U.S. failed a security screening but still assumed the post.

Both the euro and sterling have managed to recover most of their losses stemming from the war with Iran, trading near seven-week highs.

Against the Japanese yen, the dollar stabilized at 159.225 after Bank of Japan Governor Kazuo Ueda avoided signaling an imminent interest rate hike, increasing the likelihood that rates will remain unchanged until at least June.

The risk-sensitive Australian dollar reached $0.71710, near its highest level in four years, while the New Zealand dollar declined by about 0.1% to 0.5887.

In a note issued Friday, Michael Pfister, an FX analyst at Commerzbank, stated that implied currency volatility “shows almost no signs of major uncertainty,” noting that one of the bank’s tracking indicators has returned to pre-war levels.

He added: “Even if the war ends, a new crisis is surely waiting for us. This week, the U.S. President returned to his favorite topic: the Federal Reserve. Geopolitically, Cuba appears to be his next target, alongside his frequent criticisms of NATO.”

Markets Await Central Bank Response to Inflation Risks

Investors are monitoring how policymakers will handle inflationary pressures resulting from the war, as central banks have maintained a cautious approach so far.

U.S. Treasury yields stabilized on Friday after rising in the previous session, as high oil prices continued to fuel inflationary concerns.

The two-year Treasury yield stood at 3.7732%, while the benchmark 10-year yield stabilized at 4.3054%.

Federal funds contracts show that markets expect the U.S. Federal Reserve to continue holding interest rates steady this year—a clear shift from previous expectations that indicated two rate cuts before the outbreak of the war.

For their part, G7 finance ministers and central bank governors expressed their readiness to act to limit economic and inflationary risks arising from energy price shocks and supply disruptions due to the Middle East conflict, according to French Finance Minister Roland Lescure.

Similarly, European Central Bank officials adopted a cautious tone, ruling out an interest rate hike anytime soon and emphasizing the need for more data before making any decisions.

In a related context, data showed that new U.S. jobless claims fell more than expected last week, indicating continued labor market strength. This provides the Federal Reserve with room to keep interest rates unchanged for longer while monitoring the fallout of war-driven inflation.