GBP: Energy-Driven Inflation Risks Support Sterling vs Dollar - MUFG

MUFG's latest view holds that energy-driven inflation risks are providing support for GBP/USD. The institution notes that the rise in European natural gas prices is rekindling market concerns about inflation, which may force the Bank of England to tighten monetary policy again, thereby benefiting the pound. As of writing, GBP/USD was trading around 1.35816.

**Energy Costs Rekindle Inflation Worries**

The recent surge in European natural gas prices has become a new focal point for the market. MUFG analysis suggests that the upward trend in energy costs could reverse the UK's previously gradual decline in inflation, posing fresh upside risks. This contrasts with Bank of England Governor Bailey's earlier downplaying of inflation, where he stated that the "disinflationary trend remains on track," implying that the policy outlook may face renewed uncertainty.

**Rate Hike Expectations Underpin Sterling**

The return of inflation risks has directly strengthened market expectations for future rate hikes by the Bank of England. MUFG believes this expectation is a key factor underpinning the pound's exchange rate. Despite the Bank of England's previous 6-3 vote to hold rates steady, with a less hawkish tilt than expected, the impact of energy price shocks may prompt policymakers to reassess the inflation outlook, thereby providing solid support for GBP/USD.

**External Factors vs. Domestic Drivers**

Sterling's movement is currently influenced by both external and domestic factors. On one hand, the dollar remains firm due to market expectations of potential Fed rate hikes, capping the pound's upside. On the other hand, domestic energy-driven inflation risks are emerging as a new internal driver for the pound. MUFG's view indicates that, in the current environment, the influence of policy expectation shifts triggered by energy prices may be surpassing the previously dominant weak domestic factors in the UK.