MUFG highlights that United Kingdom (UK) rate expectations have flipped from cuts to a possible hike as the energy shock lifts inflation risks, supporting recent Pound Sterling (GBP) outperformance versus European peers. The Bank of England (BoE) is expected to keep rates on hold but signal concern over persistent price pressures, leaving the Pound sensitive to evolving policy guidance and energy developments.

BoE seen on hold but more hawkish

"Rate cut expectations have been scaled back even more sharply for the BoE. The UK rates market has performed an abrupt U‑turn, shifting to price the next policy move as a hike, with around 13bps of tightening priced in by year end, compared with two full rate cuts priced before the Middle East conflict."

"The Bank is expected to signal renewed concern this week about the risk of persistent inflation pressures stemming from the energy shock. In the near term, the elevated uncertainty surrounding the inflation outlook is likely to encourage a stronger majority to vote to keep rates on hold until greater clarity emerges."

"The updated communication may open the door to tighter policy if required to contain upside inflation risks, while emphasising that the policy outlook remains conditional on the duration of the energy price shock. Like the Fed, the BoE’s policy rate is judged to be mildly restrictive, which helps ease immediate pressure to respond by raising rates."

"In the FX market, the sharper hawkish repricing of UK rates has supported GBP strength against other European currencies in recent weeks. EUR/GBP has fallen back toward the lows seen since the middle of last year, around 0.8600."

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