According to MUFG’s Lee Hardman, the British Pound and UK government bonds (gilts) have experienced a strong recovery this week, attributed to a reduction in concerns over UK fiscal and inflation risks [1]. GBP/USD rebounded from a low of 1.3303 on 18th May, approaching the 200-day moving average near 1.3420 [1]. Long gilt yields have also fallen sharply, reflecting improved market sentiment towards UK assets [1].
The report highlights that a significant drop in core and services inflation has helped alleviate fears of persistent inflation in the UK, providing reassurance that underlying inflation was slowing before the anticipated impact of the energy price shock in the summer [1]. Softer UK CPI data and weakening labour market indicators have led the UK rate market to scale back expectations for Bank of England rate hikes, with the timing of the first hike now expected in July or September and only around 50 basis points of hikes priced in by year end [1].
Additionally, Andy Burnham’s commitment to maintaining the government’s current fiscal rules, which would limit the scope for fiscal loosening if he becomes prime minister, is seen as a policy 'u-turn' that eases downside risks for the pound and gilts in the near term [1].
Despite the recent rebound, MUFG cautions that downside risks for the pound remain due to the ongoing energy price shock and persistent UK political uncertainty [1].
CONCLUSION
The British Pound has strengthened on the back of easing fiscal and inflation fears, supported by softer inflation data and a more cautious outlook for Bank of England rate hikes. However, MUFG warns that risks from energy prices and political uncertainty continue to weigh on the currency’s outlook. Market participants remain watchful for further developments in these areas.