Recent developments in the Middle East have triggered a surge in gas prices, which is impacting both UK and Euro-area inflation expectations and central bank rate outlooks. Rabobank’s Senior FX Strategist Jane Foley reports that the Pound has been one of the better performing G10 currencies, supported by reduced expectations for Bank of England (BoE) easing. Previously, Rabobank had forecast two more BoE rate cuts this year in March and June, but now no longer expects further easing in 2024 due to sticky UK inflation, higher gas prices, and the UK’s sensitivity to energy costs. Market expectations for a March rate cut have fallen sharply, and only one more 25 bp BoE rate cut is priced in over a 6-month view. The removal of March rate cut hopes, coupled with higher energy prices, threatens to negatively impact both confidence and UK growth potential [1].
Similarly, Nordea’s Chief Analyst Jan von Gerich expects the European Central Bank (ECB) to stay on hold for now, closely monitoring the effects of the Middle East conflict on Euro-area growth and inflation. He notes that higher and prolonged energy prices, tight labour markets, and sticky services inflation raise upside risks to ECB rates. Nordea’s baseline forecast is for the first ECB interest rate hike in the second half of next year, but the risk of an earlier hike has increased. Fresh data show the Euro-area labour market remains tight, with unemployment falling to another record low in January, while services inflation remains sticky. The ECB’s February meeting account highlighted concerns about higher energy prices and referenced research suggesting geopolitical risk shocks act as adverse supply shocks, persistently raising inflation. However, not all Governing Council members were convinced by this view. For now, the ECB will monitor how the situation evolves [2].
Both sources emphasize the impact of the Middle East conflict on energy prices and inflation, leading to a more cautious stance from central banks. The BoE is expected to hold rates steady, with diminished prospects for further cuts, while the ECB is also likely to remain on hold but faces increased upside risks to rates. The market reaction has seen the Pound outperform the Euro in recent sessions, reflecting diverging expectations for monetary policy between the UK and Euro-area [1][2].
Forward-looking statements from Rabobank and Nordea suggest that central banks will remain vigilant, with Rabobank no longer expecting BoE rate cuts this year and Nordea maintaining its forecast for an ECB hike in the second half of next year, though the risk of an earlier move has risen [1][2].
CONCLUSION
The surge in energy prices driven by the Middle East conflict has led both the BoE and ECB to adopt a more cautious approach to monetary policy, with diminished prospects for rate cuts and increased risks of rate hikes. The Pound has outperformed the Euro as market expectations diverge. Central banks are expected to closely monitor developments, with forward guidance suggesting a hold on rates for now but heightened vigilance regarding inflation risks.