The UK was set for a fairly positive start to the year, allowing the pound to be relatively stronger against its peers. Even amid the market chaos from the war in the Middle East, the pound has been one of the better-performing currencies against the dollar’s advance. That rosy outlook was based on expectations that the British economy would pick up in the first quarter of the year.
Friday sees the release of January’s monthly GDP data, which is expected to confirm a rebound in the British economy. It could be crucial to the pound’s evolution going forward, as it will set the baseline for the effects of the war in Iran. Traders are increasingly believing that even if the war ends soon, the effects on the energy supply chain will last for months. For a country like the UK, which imports around 40% of its energy needs, that could be a significant blow to the economy.
The Varying BOE Odds
The more immediate concern for investors is how crude price oscillations will affect inflation in the UK. Even if the central bank ignores a temporary fluctuation in non-core prices, higher energy costs will inevitably push up inflation. Before the war, the BOE was nearly evenly divided between hawks and doves, with Governor Andrew Bailey casting the deciding vote on whether to cut rates or not.
As recently as a week and a half ago, there was a pretty solid consensus that the BOE would cut at its upcoming meeting next week. Since then, the odds have fluctuated widely, from completely erasing the rate cut to expecting a hike, to expecting a month’s pause, and now back to expecting a hike in the near term. All of this in reaction to crude prices, which tried to break above $100 per barrel in early trading on Thursday.
How the Pound Will React
Higher energy prices would naturally slow the economy by raising business costs. The UK is already under pressure from the highest tax burden in history, making it difficult for British businesses to drive economic growth. On top of that, higher consumer prices from the rise in crude could push interest rates higher, making it more difficult for businesses to secure loans and to increase capital costs.
All that makes pound-denominated assets unappealing to investors, who might sell pounds to access either safe havens like gold or faster-growing economies, like the US. This means that the market will likely react contrary to its usual rules, and if the odds of a more hawkish BOE increase, then the pound could suffer.
The Growth Path Out
What could counteract this is the UK economy showing signs of resilience and setting a high baseline. This means Britain has more room to withstand the market shock from the war in Iran and to provide some breathing room for the BOE. With the market already expecting higher inflation, GDP growth could become the data point with the greater impact on the currency.
UK Monthly GDP growth is anticipated to remain unchanged at 0.1% compared to December. However, this would push the rolling three-month average up to 0.3% from 0.1% as the dismal month of October rolls off. A substantial beat here could provide some cheer for cable.