How Oil Prices Affect Exchange Rates: The Iran Ceasefire and What It Means for GBP and EUR

Foreign exchange markets moved decisively this morning. The pound rose around 1 percent against the dollar crossing 1.34, its strongest level since late February. The euro crossed 1.17 against the dollar, reaching a five-week high, having gained around 1.1 percent in early European trading. The dollar itself fell to a one-month low against a basket of major currencies.

The trigger was not a central bank decision, an inflation print, or an employment report. It was a military ceasefire. President Trump announced late on Tuesday that the United States and Iran had agreed to a two-week pause in hostilities, conditional on Iran fully reopening the Strait of Hormuz to international shipping. Within hours, oil prices had dropped more than 13 percent. By Wednesday morning, the reverberations were visible in every major currency pair.

For anyone asking why a military agreement in the Persian Gulf moves exchange rates in London and Frankfurt, the answer requires understanding one of the most important structural relationships in global finance: the link between the oil market and currency valuations. That link is not incidental or temporary. It is architectural. It runs through the pricing of the world's most traded commodity, through inflation, through central bank policy, and through the flows of capital that determine how currencies are valued. This article explains how it works, and why today's moves are the clearest illustration of that relationship in several years.

To understand how oil prices move currencies, it helps to start at the foundation: the fact that oil is priced in US dollars.

This arrangement has its roots in the early 1970s. In 1971, President Nixon suspended the convertibility of the US dollar into gold, ending the post-war Bretton Woods system under which major currencies had been pegged to the dollar, and the dollar pegged to gold at $35 per ounce. The abandonment of the gold standard left the dollar unanchored.

The petrodollar system, formalised through a 1974 agreement between the United States and Saudi Arabia, provided a new source of structural demand for the currency. In exchange for US military protection and arms sales, Saudi Arabia agreed to price its oil exports exclusively in US dollars. Other OPEC members followed. The arrangement endures to this day: roughly 80 percent of global oil transactions are still denominated in dollars.

The consequences of this system for currency markets are profound and far-reaching. Because oil is priced in dollars, any country that imports oil must first acquire dollars to pay for it. This creates a constant, structural global demand for the US currency that is independent of what is happening in the American domestic economy.

It reinforces the dollar's status as the world's primary reserve currency, with over 50 percent of global currency reserves still held in dollars. And it means that movements in the oil price have a direct and immediate effect on the demand for dollars and, by extension, on exchange rates worldwide.

The relationship between oil prices and exchange rates operates through three distinct but interconnected channels. Understanding each of them is essential to understanding today's market moves.

For oil-importing countries, a sharp rise in the oil price increases the cost of a critical import, widening the trade deficit. More domestic currency must be sold to buy the dollars needed to pay for oil. As the supply of that currency in international markets rises, its value falls. For oil exporters, the reverse applies: higher prices increase export revenues, improve the trade balance, and put upward pressure on the currency.

This dynamic explains why the currencies of major oil exporters, including the Norwegian krone, the Canadian dollar, and the Russian rouble, are often described as commodity currencies: their values move broadly in line with the oil price. For net importers, the relationship runs in the opposite direction. A spike in oil prices is directly negative for the trade balance and, all else equal, for the exchange rate.

Oil is embedded in the cost structure of the entire economy. It feeds into transport costs, manufacturing inputs, agricultural production, and energy bills for households and businesses. When oil prices rise sharply, inflation follows across every sector. Central banks respond to rising inflation by raising interest rates, or by delaying planned cuts. Higher interest rates attract capital from abroad, as investors seek better returns on assets denominated in that currency. Exchange rates adjust accordingly.

This is the channel that has dominated currency market dynamics since the Strait of Hormuz closed at the end of February. The oil price shock immediately raised inflation expectations in every major economy, forcing central banks to reconsider easing cycles that had already begun. The dollar benefited from the expectation that the Federal Reserve would keep rates higher for longer than previously anticipated. Sterling and the euro came under pressure as the Bank of England and the European Central Bank faced similar dilemmas: raise rates to fight energy-driven inflation, or hold rates and risk embedding it.

The third channel is less mechanical but equally powerful. Oil price spikes driven by geopolitical supply shocks, rather than by rising demand, signal instability. They create uncertainty about the global economic outlook. In that environment, investors reduce exposure to riskier assets and rotate toward safe havens.

The US dollar, as the world's deepest and most liquid financial market, is the primary beneficiary of those flows. Risk-off episodes push the dollar up and weaken currencies perceived as more exposed to economic deterioration. Today's ceasefire news has reversed that flow. The reduction in geopolitical risk, combined with falling oil prices, constitutes a risk-on signal. Capital has rotated back toward sterling and the euro, which had been pricing in a prolonged energy shock that now looks, at least temporarily, less likely to materialise.

No discussion of oil's impact on currencies can proceed this week without understanding precisely what the Strait of Hormuz is and why its closure has been so consequential.

The Strait is a narrow channel of water, approximately 21 nautical miles wide at its narrowest point, connecting the Persian Gulf to the Gulf of Oman and the open ocean beyond. It sits between the southern coast of Iran to the north and Oman and the United Arab Emirates to the south. The two navigable shipping lanes are each roughly two miles wide, separated by a two-mile buffer zone. On an average day in 2025, approximately 138 commercial vessels transited the Strait.

The volumes involved are extraordinary. According to data from the International Energy Agency, approximately 20 million barrels of oil and petroleum products transited the Strait every day in 2025, accounting for roughly 20 percent of global petroleum liquids consumption and approximately 25 to 27 percent of all seaborne oil trade worldwide.

In addition, around 20 percent of global liquefied natural gas trade also passed through the Strait, primarily from Qatar. Nearly 34 percent of all global crude oil trade by volume moved through this single 21-mile passage.

The concentration of supply in this waterway is remarkable. Saudi Arabia alone accounts for approximately 38 percent of all crude oil and condensate transiting the Strait, at around 5.5 million barrels per day. The top five exporters, Saudi Arabia, Iraq, the UAE, Iran and Kuwait, together account for nearly 94 percent of total Hormuz crude flows.

The Strait is the only maritime export route for several Gulf states, including Qatar, Kuwait and Bahrain, which have no pipeline alternatives. Saudi Arabia and the UAE do operate bypass pipelines, but their combined available spare capacity is estimated at between 3.5 and 5.5 million barrels per day, covering well under a third of normal Strait volumes. There is no combination of alternatives that could replicate the Strait's function at scale and at speed.

When Iran's Revolutionary Guard Corps formally declared the Strait closed to Western-allied shipping on 2 March 2026, following the assassination of Supreme Leader Ali Khamenei and the initial US and Israeli military strikes on 28 February, the effect on global energy markets was immediate and severe.

Tanker traffic, which had averaged 138 vessels per day, had effectively ceased within days. On 7 March, according to tracking data, a single commercial vessel transited the Strait. Iraq, Saudi Arabia, Kuwait, the UAE and Qatar collectively curtailed production as storage capacity filled and exports became impossible to move. By mid-March, according to estimates from Rystad Energy, nearly 17.8 million barrels per day of oil and fuel flows had been disrupted.

The scale of what happened to oil prices between 28 February and 7 April is without modern precedent.

Brent crude, the international benchmark, was trading at approximately $71 to $73 per barrel in the days before the initial strikes on Iran. By 8 March it had crossed $100 per barrel for the first time since July 2022. It hit an intraday high of $119.50 on 9 March as analysts warned of a game-changing energy crisis.

Brent's monthly gain in March was approximately 55 percent, a record for the contract since its inception in 1988. The previous monthly record had been a 46 percent gain in September 1990, during the first Gulf War. At its recorded peak, Dated Brent reached $144.42 per barrel, surpassing the 2008 record set during the global financial crisis, according to S&P Global Platts.

By any measure, this was the largest disruption to the global oil supply in the history of the modern oil market. The IEA authorised the release of its largest-ever reserve stockpile to try to stabilise prices, but with approximately 500 million barrels of total liquids lost from global supply by late March, even that release represented only a limited buffer.

The effect on inflation expectations was immediate. In the United States, where the consumer price index had been running at around 2.8 percent before the war, analysts at major banks revised their inflation forecasts upward sharply. EY-Parthenon revised its baseline to just one rate cut in 2026, while noting it was entirely plausible there would be none. Bond markets drove the probability of a Federal Reserve rate cut in 2026 to well below 25 percent. Petrol prices in the United States rose approximately 88 cents per gallon in the month following the start of the conflict.

In the United Kingdom, the picture was similarly dramatic. UK CPI inflation had stood at exactly 3 percent in February, and had been expected to continue falling toward the Bank of England's 2 percent target in spring 2026. The energy shock overturned those expectations entirely.

UK inflation was revised upward to a forecast range of between 3 and 3.5 percent for the second and third quarters of 2026, according to preliminary Bank of England estimates published on 19 March. Some analysts at Deutsche Bank and ICAEW warned of a further spike above 4 percent by the autumn if the conflict continued.

The impact on mortgage markets was swift. Lenders withdrew over 1,500 products from the UK market in the weeks following the outbreak of war. Two-year fixed rates rose from around 4.8 percent to approximately 5.5 percent, adding close to £1,000 per year to costs for a typical £200,000 borrower.

The US dollar's behaviour during the Strait of Hormuz crisis illustrates a structural tension that sits at the heart of dollar economics.

In the immediate aftermath of the initial strikes on Iran, the dollar strengthened. This reflected the currency's primary role as the world's safe-haven asset. In periods of severe geopolitical stress, institutional investors and sovereign funds reduce exposure to riskier currencies and rotate into dollar-denominated holdings.

The dollar's unmatched liquidity, the depth of US Treasury markets, and its status as the global reserve currency all underpin this dynamic. It happens almost automatically during crises. The oil price shock also supported the dollar via the interest rate channel: if the Federal Reserve was going to hold rates higher for longer, dollar assets became more attractive to capital seeking yield.

But the dollar's safe-haven premium rests on fragile assumptions when the shock is inflationary rather than deflationary. Unlike a financial crisis or a recession, which tends to be deflationary, an oil supply shock raises prices across the economy.

The United States imports significantly less oil than it did in previous decades. US crude imports from Persian Gulf countries via the Strait of Hormuz amounted to only around 0.5 million barrels per day in 2024, accounting for roughly 2 percent of total US petroleum liquids consumption. The shale revolution transformed the US from a major oil importer to a net exporter of petroleum products in late 2019. So the terms-of-trade impact on the US is more limited than on the UK or eurozone.

However, oil priced above $100 per barrel raises costs for US businesses and consumers regardless of domestic production capacity. Gasoline prices surged. Shipping and transport costs climbed. Agricultural input costs rose. The Federal Reserve found itself in the same stagflationary bind as every other major central bank: inflation rising, growth threatened, and no clean policy response available.

By late March, analysts at Wells Fargo were noting that the dollar had traded well ahead of its fair value and that the accumulation of long dollar positions had become stretched. The conditions for a reversal were building. The ceasefire provided the catalyst.

No major economy outside the Gulf states has been more exposed to energy price shocks than the United Kingdom.

The UK imports approximately 40 percent of its oil supplies and up to 60 percent of its natural gas, according to 2025 data. Despite retaining some production from the declining North Sea fields, the UK is structurally a price-taker in global energy markets, as the British government itself acknowledged shortly after the conflict began, noting that the price of oil and gas is determined by international markets, not the UK.

This exposure means that when global energy prices spike, the inflationary transmission into the UK economy is faster and more severe than in more energy self-sufficient economies.

Before the war began, the Bank of England's Monetary Policy Committee was widely expected to cut its benchmark rate at the 19 March meeting. Inflation had been falling, standing at 3 percent in the February CPI print, and was projected to reach the 2 percent target in spring 2026. Four of the nine MPC members had voted for a cut at the February meeting. A March reduction was described as nearly certain by market participants.

The Bank held its rate at 3.75 percent on 19 March in a unanimous nine-to-zero decision, the first unanimous hold in over four years. Governor Andrew Bailey stated that war in the Middle East had pushed up global energy prices, visible already at the petrol pump, and warned that if the conflict persisted it would feed into higher household energy bills later in the year.

The Bank's preliminary estimates projected CPI inflation at between 3 and 3.5 percent for Q2 and Q3 2026. MPC member Megan Greene warned that the risk of inflation persistence had risen, perhaps significantly, justifying caution in monetary policy.

Markets repriced aggressively. By late March, investors were pricing approximately a 70 percent probability that the Bank of England would raise its benchmark rate before year-end. Just two weeks earlier, those same markets had been pricing two rate cuts in 2026. Traders had moved from pricing cuts to pricing hikes in a matter of days.

That reversal of rate expectations had a mixed but broadly negative effect on sterling. Higher rate expectations supported the pound's yield premium over other currencies. But they also reflected a worsening domestic outlook. Rate hikes designed to suppress energy-driven inflation carry a significant economic cost, particularly in a country where mortgage lending is heavily weighted toward shorter fixed terms.

Today, the ceasefire has begun to unwind those expectations. Lloyds Bank noted this morning that pricing in of rate hikes had gone too far in the escalation phase, and that some continued reversion was warranted on news of the ceasefire. A market that had been bracing for higher borrowing costs is now revising that outlook, and sterling is rising as a result.

The European single currency has moved for largely parallel reasons, amplified by Europe's deep structural dependence on imported energy.

The eurozone has no domestic oil industry of comparable scale and imports the vast majority of its petroleum requirements. Research from the European Central Bank and academic institutions consistently shows that oil price spikes cause short-term euro depreciation, as higher import costs widen trade deficits and exert downward pressure on the currency. One study noted that a positive oil price shock results in a temporary decline in the euro's value, with effects that can persist for up to twenty quarterly periods.

The LNG dimension added a further layer of European vulnerability in this crisis. Europe sources between 12 and 14 percent of its LNG from Qatar, with virtually all of those cargoes transiting the Strait of Hormuz. On 4 March 2026, following attacks on QatarEnergy's facilities at Ras Laffan and Mesaieed, Qatar declared force majeure on its gas contracts and halted LNG production.

Dutch TTF natural gas prices spiked nearly 70 percent through the first week of March. European buyers were competing for scarce spot cargoes at massively elevated prices on international markets.

The ECB, like the Bank of England and the Federal Reserve, faced a stark dilemma. Before the conflict, it had been on a clear easing trajectory. The energy shock complicated that path decisively. ECB Governing Council member Peter Kazimir warned that the rise in oil prices could compel the central bank to increase borrowing costs, echoing the Bank of England's internal debates about second-round effects in wage and price-setting behaviour.

EUR/USD had been broadly consolidating before the war. The dollar's safe-haven surge pushed the pair lower initially, before ceasefire speculation began to support the euro from early April. Today's confirmed ceasefire has removed the most acute inflationary risk premium from the equation. Oil is falling, LNG spot prices are retreating, and the probability of ECB rate hikes has diminished. EUR/USD at 1.17 reflects that reversal: a euro recovering lost ground as the energy shock that had been weighing on it shows signs of easing.

The scale of this morning's currency moves, roughly one percent in less than a session, merits explanation. Currency markets do not often move by that magnitude on a single piece of news.

The answer lies in the concept of the risk premium. Over the past five weeks, every asset price in the market had been repriced to incorporate a significant probability of a prolonged energy crisis. Oil futures were carrying a substantial war premium above their underlying supply-demand value. The dollar was carrying a safe-haven premium above its fundamental value. Sterling and the euro were both trading below levels consistent with their economic fundamentals in the absence of the shock.

When the ceasefire was announced, all of those premia began to unwind simultaneously. Oil fell 13 percent. The dollar's safe-haven bid evaporated. The expectation that the Bank of England and ECB would need to raise rates began to reverse. The risk-on signal encouraged investors who had been holding defensive positions to rotate back into sterling and euro-denominated assets, driving demand for those currencies.

The move is, in the language of market structure, a mechanical unwind rather than a fundamental reassessment. The ceasefire has not yet been followed by the full reopening of the Strait. It lasts two weeks and is conditional.

But markets price probabilities, not certainties, and the probability distribution of outcomes shifted materially overnight. The most extreme scenarios, sustained closure for months, oil above $140, multiple central bank rate hikes, have become significantly less likely. Markets are repricing away from tail risk, and currencies are moving accordingly.

Today's events sit within a longer historical pattern that is worth understanding.

The first major oil shock of 1973, following the Arab oil embargo in response to Western support for Israel in the Yom Kippur War, quadrupled oil prices within months and triggered a global recession. The dollar, despite being the currency in which oil was priced, fell against major currencies as the inflationary consequences of the shock overwhelmed its structural advantages.

The second oil shock of 1979, following the Iranian Revolution, doubled oil prices again and contributed to the stagflation that characterised the early 1980s. The dollar subsequently strengthened sharply as the Federal Reserve under Paul Volcker raised rates aggressively to suppress inflation, pushing the dollar to historically elevated levels against sterling and other major currencies.

The 1990 Gulf War caused a 46 percent monthly spike in Brent crude, a record that stood for 36 years until it was surpassed by events in March 2026. The dollar initially strengthened on safe-haven flows before retreating as the conflict ended quickly and oil prices fell sharply.

The 2022 Russian invasion of Ukraine caused Brent to spike from around $80 per barrel to nearly $130 within weeks. The dollar strengthened, the euro fell sharply as Europe confronted its dependence on Russian gas, and sterling came under broad pressure. The war premium in that episode peaked at an estimated $47 per barrel and gradually dissipated as Russian oil found alternative buyers.

What distinguishes the 2026 Strait of Hormuz crisis is its structural character. Unlike Ukraine, where the supply disruption was partial and Russia continued exporting oil through alternative routes, the closure of the Strait represented a near-total blockage of the world's most critical energy chokepoint, with no available alternatives of comparable scale.

The IEA itself described a full Strait closure as capable of dropping global LNG supply by over 300 million cubic metres per day, double the average throughput of the Nord Stream pipeline, a shortfall that no combination of alternative suppliers could replace at short notice.

Whether the ceasefire now leads to a durable reopening, or whether the Strait remains contested, will determine how much of the risk premium is permanent and how much is temporary. Markets are, this morning, betting heavily on the former.

The past five weeks have compressed into a single episode every mechanism through which oil prices move exchange rates: the terms-of-trade deterioration for import-dependent economies, the inflationary transmission into central bank policy, the safe-haven dynamics that temporarily inflated the dollar, and the risk sentiment unwind that has driven this morning's sterling and euro gains.

For those seeking to understand foreign exchange markets, the core lesson is this: currencies do not move in isolation from the physical economy. They are deeply connected to commodity markets, to the energy infrastructure that underpins global trade, and to the policy responses of central banks trying to navigate the consequences of supply shocks.

A pipeline in the North Sea, a waterway between Iran and Oman, a policy decision in Washington or London, all of these translate into exchange rate movements through channels that are consistent, well-documented, and increasingly well understood.

The ceasefire announced yesterday is a two-week pause in a conflict that has already caused the largest disruption to global energy supply in the history of the oil market. The Strait of Hormuz remains what it has always been: 21 nautical miles that the entire global economy funnels through, with almost no backup plan. Whether those miles remain open in the weeks ahead will continue to be one of the most consequential questions in financial markets.

Related Reading:
FX Market Outlook April 2026: Inflation, Volatility and Central Bank Risk
Weekly FX Roundup: Energy Shock Reshapes Currency Markets as Iran War Deepens
USD Market Insight: Dollar Strength Rebuilds as Yields, Policy Tone and Risk Dynamics Shift