FOREX-Dollar edges higher as Middle East war boosts safe-haven demand

By Niket Nishant and Rae Wee

LONDON/SINGAPORE, March 5 (Reuters) - The dollar resumed its climb on Thursday after a brief retreat from three-month highs as the fallout from the Middle East conflict kept investors on edge and prompted a flight to the safe-haven currency.

Earlier hopes of a de-escalation gave way to a fresh bout of uncertainty, with Iran warning that Washington would "bitterly regret" the sinking of an Iranian warship off Sri Lanka.

That kept the dollar in favour, leaving the euro EUR=EBS down 0.18% at $1.1610 and sterling GBP=D3 0.1% lower at $1.3358.

The dollar index =USD, which measures the greenback against a basket of six other currencies, was last up 0.18% at 98.99.

"Everyone is fumbling around in the dark," Nick Rees, head of macro research at Monex, said.

"Most investors recognise that they do not have a high level of confidence when it comes to the outlook over these tensions, and it is leaving markets highly reactive to even small headline developments."

As the turmoil triggered a flight to safety, renewed inflation worries muddied the outlook, leaving some traditional havens behaving unpredictably and forcing investors to reassess which assets truly offer protection.

Yields on the 10-year German Bunds DE10YT=RR, the euro zone benchmark, were 6.1 bps higher at 2.807% on Thursday as prices fell. GVD/EUR

'NO ESCAPE'

"There appears to be little to no escape. Traditional safe havens, such as gold, are not playing their usual part," Bas van Geffen, senior macro strategist at Rabobank, said.

"Considering the sharp appreciation of the DXY index, dollar liquidity appears to be king."

The dollar has risen nearly 1.37% for the week thus far, emerging as one of a handful of winners in a volatile few sessions that have dragged stocks, bonds and, at times, even safe-haven precious metals lower.

The spike in energy prices from the Middle East war has stoked fears of a resurgence in inflation that could derail the rate outlooks for major central banks.

Traders are now pricing in just a 31.5% chance of a Federal Reserve rate cut in June, compared with a near 46% chance a week ago, according to the CME FedWatch tool, though that has in part been driven by upbeat U.S. economic data on Wednesday. 0#USDIRPR

Rate-easing expectations from the Bank of England have also been pared back 0#GBPIRPR, while money markets increased bets on European Central Bank rate hikes as early as this year 0#EURIRPR.

"In addition to market participants, it is central bankers who are now increasingly eyeing the return of inflation as a concern," Thierry Wizman, global FX and rates strategist at Macquarie Group, said.

"It is the U.S.' rate outlook that is seen to have the greatest potential to be overturned by another burst of global inflation in 2026, if energy supplies become constrained."

The yen JPY= similarly reversed early gains and was last 0.2% lower at 157.35 per dollar.

Elsewhere, China set its economic growth target for 2026 at 4.5% to 5% on Thursday, a slight downgrade from the 5% pace achieved last year, which left room for greater - although not decisive - efforts to curb industrial overcapacity and rebalance the economy.

The yuan CNY=CFXS rebounded from a one-month low and was last trading flat at 6.8951 per dollar, after the People's Bank of China set its guidance at the strongest in nearly three years.

In cryptocurrencies, bitcoin BTC= and ether ETH= fell less than 1% each, after strong gains in the previous session.