MUFG’s Head of Research Derek Halpenny warns that the Pound’s (GBP) strong March performance looks vulnerable. He links Sterling’s gains mainly to yields, while highlighting the UK’s rising energy import dependency, shrinking refinery capacity, and risks of refined fuel shortages. With potential risk aversion and a larger terms-of-trade hit, he sees an increased risk of a reversal in recent Pound resilience.

Sterling at risk from energy shock

"So, the recovery in risk is likely to remain fragile with doubts set to return over the improvement in energy supply conditions."

"For the UK, the vulnerability looks greater and hence the pound performance is of greater risk of turnaround. In reality, the pound performance looks more yield-related."

"The UK’s overall energy import dependency is rising due to the decline in North Sea oil production and has now reached close to 45%. Oil and gas make up about 90% of the UK’s energy imports and refined fuel imports have grown with diesel and jet fuel the main imported refined products. The UK’s refinery capacity has fallen steadily over time from as many as 18 refineries in the early 1980’s to just 4 now."

"The price of jet fuel has doubled in the current energy shock while diesel prices are rising faster than petrol prices. According to RAC Fuel Watch, the price of petrol has increased by about 13% while diesel prices are up close to 25%. The CEO of Shell has stated that Europe could experience refined fuel shortages later this month."

"With risk aversion potentially set to rise as global growth fears increase and given the vulnerability of the UK to a bigger terms of trade hit and potentially fuel shortages, the pound could be set to reverse its relative resilience seen in March."

"If this renewed optimism translates to sharp falls in energy (a big if at this stage) the surge on front-end yields will likely reverse and reinforce a potential correction for the pound."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)