After a tense start to the week, Sterling is ending it in a stronger position.
Reports of potential new US military operations in Iran led to oil spiking to the highest levels since the start of the conflict earlier this week (Brent crude hit above $125/barrel). It’s since receded but remains at elevated levels as the Strait of Hormuz continues to be blocked and with no resolution in sight. Attention then turned to a busy week of central bank interest rate decisions.
As expected, the Federal Reserve, ECB, and Bank of England all voted to keep rates on hold and the tone across all three reflected a shared concern about the inflationary implications of prolonged high energy prices. The Fed vote was the most divided it has been since 1992 (8-4 vote split) and with incoming Chair Kevin Warsh expected to push towards lower interest rates, many analysts believe the next move in US rates is down rather than up. Conversely, yesterday’s BoE and ECB meetings indicated they looked more inclined to raise rates than cut them.
The ECB held unanimously, but President Lagarde's press conference disappointed those expecting a firmer signal on future rate hikes. Although she acknowledged that a rate rise had been discussed, her overall tone was more cautious than markets had anticipated. They noted that the Euro area came into this period with inflation near target and a relatively resilient economy which they believe gives them a buffer to absorb some of the heavier shocks of this energy crisis and the power to not make any rash policy decisions. A June hike remains close to fully priced in, though expectations for the total number of hikes this year have begun to ease, which led to some weakening in the Euro (particularly against GBP).
The Bank of England voted 8-1 to hold, with chief economist Huw Pill the only one calling for an immediate hike. Policymakers seem alert to the risk of inflation running hot but also aware that the oil shock is likely temporary and that a softer labour market should keep a lid on wages. However, the Governor also made it explicitly clear that they were prepared to act pre-emptively if energy-driven price pressures did begin to feed into wages (to avoid a wage-price spiral). This was taken by markets as being more hawkish than the other central banks' tones and therefore made Sterling more attractive to investors seeking higher yields.
As a result, the GBP/USD rate has rallied by around 1.2% from yesterday morning and now trades at a 10-week high. The GBP/EUR pushed up by over half a cent yesterday and trades towards the higher end of where it's traded since the end of August. With central banks in wait-and-see mode and war risk continuing in the background, the direction of travel for rates will continue to be shaped by incoming data and any meaningful developments in the Iran peace process.
