MUFG reports that UK rate expectations have shifted dramatically, moving from anticipated cuts to the possibility of a rate hike as the energy shock increases inflation risks. This shift has underpinned recent outperformance of the Pound Sterling (GBP) against European peers, with the Bank of England (BoE) expected to keep rates on hold but signal concern over persistent price pressures. The UK rates market has performed an abrupt U-turn, now pricing in around 13 basis points of tightening by year end, compared to two full rate cuts previously expected before the Middle East conflict [1].
The BoE is anticipated to communicate renewed concern about persistent inflation pressures stemming from the energy shock, encouraging a stronger majority to vote to keep rates on hold until greater clarity emerges. The updated guidance may open the door to tighter policy if required to contain upside inflation risks, while emphasizing that the policy outlook remains conditional on the duration of the energy price shock [1]. MUFG notes that, similar to the Federal Reserve, the BoE’s policy rate is considered mildly restrictive, which helps ease immediate pressure to respond by raising rates [1].
In the foreign exchange market, the sharper hawkish repricing of UK rates has supported GBP strength against other European currencies in recent weeks. Specifically, EUR/GBP has fallen back toward the lows seen since the middle of last year, around 0.8600 [1].
CONCLUSION
The Bank of England's hawkish repricing, driven by inflation risks from the energy shock, has strengthened the Pound against European currencies. With rate cut expectations replaced by the possibility of a hike and increased market uncertainty, GBP remains sensitive to evolving policy guidance and energy developments.