Pound slides to three-week low as Middle East tensions and gilt yields weigh

The British pound slipped to a three-week low against the US dollar on Wednesday, as escalating Middle East tensions and renewed pressure in the UK government bond market kept investors cautious.

Sterling was last down 0.05% at $1.3510, after touching $1.3490 earlier in the session — its weakest level since August 14. The dollar, meanwhile, climbed to a two-week high as traders sought refuge in the US currency amid worries over a potential energy shock and diverging monetary policy expectations across major economies.

In the UK, government bond yields hit fresh 18-year highs, adding to the fiscal challenges facing finance minister John Healey ahead of his first budget, scheduled for October 28. Healey has said he will stick to the borrowing rules inherited from his predecessor, Rachel Reeves.

Market analysts noted that the rise in yields could directly erode the government's fiscal headroom, raising the likelihood of tax increases in the autumn. One-month implied volatility in sterling has fallen to levels not seen in over 12 years, though some strategists expect that to mark a floor given brewing budget jitters.

The euro was little changed against the pound, trading at 85.72 pence.

The Bank of England's policy path remained in the background, with the central bank widely expected to hold rates at 3.75% this month. Markets are pricing in a quarter-point increase by the end of the year. Some economists argue that higher inflation, firming household expectations, and a stabilising labour market reduce the need for looser policy, though the debate over whether rates remain sufficiently restrictive is expected to intensify in the coming months.