The prospect of a protracted energy crisis in Europe is clouding the outlook for the pound and outweighing any boost it will receive if investors value a faster pace of rate hikes.
With the continent struggling with a gas shortage and the UK further hampered by damage to its supply network, there is a risk that inflation will continue to accelerate this winter, causing consumption to decline. Consistently high energy prices also threaten to widen the country’s current account deficit, according to Deutsche Bank AG, weighing on the currency.
While traders are now betting that the Bank of England will raise interest rates faster than previously expected, the pound has lagged its main counterparts over the past month. That’s a change in a relationship that the currency tends to see rise as the market prepares for tighter monetary policy, underscoring the headwinds the economy is facing.
“Even if market price rates in the BOE rise more due to the gas price hikes, I don’t think the pound will follow higher,” said Shreyas Gopal, a strategist at Deutsche Bank in London.
Eyes now turn to the BOE policy meeting next week for any evidence that rising power prices will affect its considerations. Signs that customers are starting to control consumption due to rising utility bills could be enough to delay a tightening, said Jane Foley, Rabobank’s chief currency strategist.
“Even though it will drive up the CPI index, it’s not the kind of inflation the Bank of England would respond to with a rate hike,” Foley said. On the contrary, “they would probably look more cautiously at the price trend.”
All this against the backdrop of Brexit- and Covid-19-induced supply difficulties, which Barclays Bank Plc said could lead to inflationary pressures manifesting “even at lower levels of growth”.
While inflation is at its fastest pace in more than nine years, fueling speculation that more aggressive officials will gain the upper hand in setting policy, poor retail data on Friday still points to weakness in the economy.
Money market traders see the BOE raise its key rate to 0.5% in November 2022, shifting bets this week to next year. The first increase of 15 basis points is expected in May 2022.
“We are in a world of slowing growth, but potentially higher rates – something the markets haven’t seen in a while,” said Jordan Rochester, a strategist at Nomura International Plc.
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