FOREX-US dollar climbs as Middle East conflict intensifies, boosting safe-haven demand

By Niket Nishant and Gertrude Chavez-Dreyfuss

LONDON/NEW YORK, March 5 (Reuters) - The dollar resumed its climb on Thursday, rebounding from a brief pullback from three-month highs, as an escalating conflict in the Middle East kept investors on edge and drove demand for safe-haven assets.

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.

The conflict entered its sixth day with more intensive bombing, while Iran vowed to retaliate anywhere for a U.S. attack on a ship thousands of miles from the battle zone.

That kept the dollar in favor, leaving the euro EUR=EBS down 0.4% at $1.1579 and sterling GBP=D3 0.3% lower at $1.3329.

The dollar index =USD, which measures the greenback against a basket of six other currencies, was last up 0.5% at 99.257.

"De-dollarization has been a huge narrative last year and maybe even part of the year before that. Everyone was looking somewhere else. People are asking: Is the U.S. dollar really a store of value?" said Elisabeth Colleran, co-head of the emerging markets debt team at Loomis Sayles in Boston.

"But this week we see when we have heightened volatility and heightened risk, the dollar certainly rallies, and all currencies, euro included, are pushed down."

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.

Investors sold both German Bunds and Treasuries, with benchmark yields on those rising to 2.829% DE10YT=RR and 4.138% US10YT=RR, respectively.

With the war in focus, currency investors shrugged off Thursday's economic data.

The number of Americans filing new applications for unemployment benefits was unchanged last week, while layoffs dropped sharply in February, consistent with stable labor market conditions.

Initial claims for state unemployment benefits were flat at a seasonally adjusted 213,000 for the week ended February 28, data showed. Economists polled by Reuters had forecast 215,000 claims for the latest week.

'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 1.5% for the week thus far, on track for its best weekly gain since November 2024. It's 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 have pushed back the time frame for the next easing by the Federal Reserve to either September or October, according to LSEG estimates, though that has in part been driven by upbeat U.S. economic data on Wednesday. 0#USDIRPR

U.S. rate futures have also reduced the magnitude of rate cuts this year to just 40 basis points, down from 59 bps before the Middle East conflict.

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."

In other currency pairs, the dollar rose 0.4% against the yen to 157.72 yen JPY=.

Against the Chinese yuan, the dollar gained 0.2% to 6.9058 CNH=.

China earlier on Thursday set its economic growth target for 2026 at 4.5% to 5%, 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.

In cryptocurrencies, bitcoin BTC= and ether ETH= tumbled after strong gains in the previous session. Bitcoin was last down 1.5% at $72,236, while ether dropped 2.2% to $2,094.64.