MUFG: The GBP - FJElite

The BoE’s hawkish policy update initially lifted UK yields and sterling, although both subsequently reversed as the global AI-related equity sell-off intensified. UK yields have nevertheless outperformed other major markets, supported by the Bank’s signal that further tightening is likely. Governor Bailey indicated there was a strong case for another hike if the US-Iran conflict remains unresolved, a view broadly shared by several MPC members. While the base case remains for another increase in February, the risk of a December hike has risen, with markets pricing around 13bp of tightening by year-end.

However, the outlook remains heavily dependent on energy prices. Bailey stressed that the BoE will focus on developments in oil markets, and the recent sharp decline in crude was not reflected in its latest forecasts. If lower prices persist, potentially reflecting progress towards a US-Iran agreement, the Bank may delay further tightening. After one additional hike, the case for continued increases becomes less clear, with policymakers emphasising that a sustained sequence of hikes is not inevitable. The MPC will monitor second-round inflation effects into 2027, while a deeper AI equity sell-off and tighter global financial conditions could also reduce the appetite for further tightening.

Sterling has benefited from stronger UK growth, higher yields and a relative improvement in the UK’s fiscal position compared with the euro area. The BoE acknowledged that activity has surprised to the upside, partly reflecting stronger exports and AI-related investment and productivity gains. Stronger growth suggests less spare capacity and supports the case for tighter policy, although it remains unclear whether the productivity improvement represents a lasting increase in supply capacity. Overall, the hawkish policy signal should support sterling into year-end, although its sensitivity to global risk sentiment leaves it vulnerable to a deeper technology-led sell-off.