Markets will be looking at the upcoming UK data to get a baseline for how energy price increases could affect the economy. This will be important in determining the timing of the first BOE hike and could therefore influence pound pairs. Cable has been performing better this week, mostly amid weakness in the dollar. But Britain does have some reasons to offer more resilience in the current environment than its European peers, and keep the pound elevated.
The important context for the data release is last week’s BOE rate decision, which markets saw as more hawkish than expected. All MPC members voted to keep rates unchanged, as we anticipated, opting to wait a month for more data to determine where policy could go. Following the meeting, markets priced in two rate hikes this year, with a 40% chance of the first one being as soon as April.
A Major Change in Direction
Before the war, markets were expecting the BOE to continue a generally slow easing cycle. That’s because inflation was still above target but was expected to fall below it over the course of the year, driven by increasing slack in the labour market. In fact, the labour data was more important in determining the outlook for the pound because it was the measure most closely followed by the BOE.
Now that higher energy prices are expected to push up inflation, the already high inflation before the war even began is a major problem for the pound. On top of that, the extremely narrow headroom in the government’s finances means it has much less scope to deal with higher prices than it did back in 2022. And if the BOE raises rates, depressing the economy, the government will have even less revenue to allocate towards controlling energy prices.
The Timing Is the Crucial Part
All of this means that markets are extra sensitive to the timing of the BOE’s rate hike. If it’s sooner, the economy will come under pressure, which will cause more problems for the government’s finances and weigh on pound-denominated assets. If there is a delay, then the situation in the Middle East might be resolved before the BOE has to hike, or it might not be as bad as feared.
Markets are likely to look past the inflation data to determine how much hiking the BOE will do, since that’s entirely in response to the energy supply shock. What can change is when they expect the first hike to occur. If inflation has increased, then that means there is less room for the BOE to hold off on tightening, raising the odds of an April hike. But if inflation has fallen a bit, the BOE could hold off for another month to get a clearer picture of the economic impact of the war, which could end up supporting the pound.
What the Market is Looking For
The consensus is that both the headline and core UK February CPI readings will stay unchanged at 3.0% and 3.1% respectively. Declining oil prices at the start of the year were seen as helping to reduce inflationary pressure. Now that the situation has reversed.
Where the pound could benefit is that the UK imports around 50% of its oil needs, which is much less than the over 90% that the EU does. However, it’s still priced in Brent, meaning the inflation impact will be similar. On the other hand, it means that the UK will have to spend fewer pounds to import energy, which could mean the pound is slightly better off than the Euro while prices remain high.