The US dollar edged lower on Tuesday as investors balanced escalating tensions in the Middle East against optimism fueled by softer-than-expected US inflation data released last week.

The euro rose 0.09% against the dollar to $1.1424, while the Japanese yen slipped 0.09% to 162.63 per dollar.

The mixed moves reflected growing uncertainty across financial markets as investors struggled to assess the economic impact of rapidly evolving developments in the Middle East.

Geopolitical tensions support the dollar, diplomacy limits gains

The US military carried out a tenth consecutive night of airstrikes against Iran, reviving geopolitical concerns and prompting investors to scale back bets on a near-term end to the conflict, a backdrop that typically supports demand for safe-haven assets such as the US dollar.

At the same time, diplomatic efforts continued. A senior Iranian official told Reuters on Monday that Tehran had received, through mediators, a proposal for a 10-day ceasefire.

The lack of clarity over the direction of the conflict has left the dollar trading in a narrow range, with investors reluctant to take large positions.

Inflation and oil prices cloud the outlook

Uncertainty over inflation also kept investors cautious after softer-than-expected US inflation data last week reduced expectations for additional Federal Reserve rate hikes, limiting support for the dollar.

However, the inflation outlook remains uncertain and will depend largely on when shipping through the Strait of Hormuz returns to normal and oil markets stabilize.

According to LSEG data, traders continue to expect at least one additional Federal Reserve rate hike this year.

Brent crude futures fell 1.1% on Tuesday but remained about 21% higher since the beginning of the month.

"We think any sustained weakness in the US dollar is more likely to be a 2027 story," said Jimmy Jean, Chief Economist and Strategist at Desjardins. "We expect the dollar to remain relatively strong over the coming months until the inflation outlook becomes clearer."

The US Dollar Index, which measures the greenback against a basket of six major currencies, slipped 0.05% to 100.9 after reaching its highest level since July 15 in the previous session.

Canadian dollar steadies after new US tariffs

The Canadian dollar stabilized after falling to a one-month low following Washington's decision to impose new 50% tariffs on a broad range of Canadian products in response to what the United States described as discriminatory treatment of US automobiles, alcoholic beverages, and dairy products.

Sterling rebounds as UK enters new political chapter

The British pound rose 0.1% to $1.3441, snapping a three-session losing streak.

The move came after Andy Burnham became the UK's new prime minister, the country's seventh leader in a decade, while pledging to maintain the fiscal discipline framework established by the previous government.

Former Defence Secretary John Healey was also appointed Chancellor of the Exchequer.

Burnham has yet to provide details on how he intends to achieve his economic objectives while honoring his election pledge not to raise taxes on working people.

"The key near-term risks remain the UK's fiscal position and Burnham's commitment to the fiscal rules adopted by the previous government," said Shaun Osborne, Chief FX Strategist at Scotiabank.

Meanwhile, investors are looking ahead to the European Central Bank's policy meeting later this week. Economists surveyed by Reuters expect the ECB to leave interest rates unchanged while signaling that at least one additional rate hike remains possible before the end of the year.