How have the latest macro data & political developments impacted the outlook for the GBP?

Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday 22nd May 2026, and joining Lee to pose some questions on the financial market themes for the week ahead is Henry Cook, Senior Economist. This material is only intended for professional investors in jurisdictions in which its use is permitted under applicable laws, rules and regulations.

It has been produced for information purposes only and should not be construed as investment research or advice. MUFG EMEA disclaimers and disclosures can be located on our website. Hi Henry, hi Lee.

Thanks for joining the podcast again today. As we've seen over the past week, it's been a very volatile week for UK markets. We've seen gilts and the pound staging strong rebounds.

If you look at the 30-year gilt yield, that's fallen sharply by almost 30 basis points this week. And similarly in the FX market, we've seen the pound strengthened by around 1% against the euro. On top of that, we've also seen some interesting economic data releases from the UK this week, which have caught the market attention, namely the latest UK labour market and CPI reports.

Would be interesting to hear if these reports have altered your view in any way on the outlook for the UK economy. Yeah, yeah, you're right. It's been a busy week for UK macro data.

We had the labour market numbers on Tuesday, inflation on Wednesday, PMI business survey on Thursday. And then today, we had retail sales and public finances as well. So it's been busy.

What I would say is that in general, the numbers have been on the soft side for the UK economy. The labour market numbers came with plenty of caveats, there was a sharp drop in the employment numbers. I expect that will be revised upwards later on.

But yeah, the general picture is that the UK labour market has plenty of slack. That kind of remains valid. The PMIs, they were soft as well.

The services component has not been weaker since the pandemic. Q1 GDP was good, of course. I think we've talked about that before and that there is a degree of momentum which will be carried forward.

But yeah, it's clear that UK activity will slow over the coming months. Retail sales, public finance numbers, yeah, they were weaker as well. The good news came in the inflation number, headline inflation, 2.8 percent.

That was down from 3.3 percent in March. April is always a key month with lots of moving parts, annual price resets, interventive, government policy, energy price caps. But it also worked out to produce a number which was below our expectations, below the Bank of England's expectations and the consensus.

So, yeah, a good outcome. What I would say is, as it stands, the only obvious impact of the conflict in Iran on inflation is through fuel prices. That's the only impact so far.

Unfortunately, that will change. Other numbers this week made it clear that there is plenty of inflation in the pipeline in the UK. Producer input prices rose almost 8 percent, I think, year on year.

Factory gate prices, 4 percent. It will still take a while for the impact of the war to kind of percolate through the economy, but it will happen. But there's going to be a big step up in July when the household energy price cap in the UK increases somewhere in the region of 10 to 15 percent, I think.

And then food prices, airfares and other components, they're all going to start to kind of reflect the impact of the energy shock. So, yeah, even if there is a settlement between the US and Iran quite soon, that we still see UK inflation as being on course to exceed 4 percent by year end. So, yeah, I guess in that light, this week's number should be seen as temporary relief only, unfortunately.

And we do have this kind of looming real income squeeze, which is going to increasingly weigh on UK activity. So what do you think, how do you think the Bank of England will kind of weigh up this latest data? Obviously, we're waiting to see how the Middle East conflict is going to play out and impact the economy going forward before making any kind of decisions to adjust policy.

Do you think the latest data this week will change their views on policy in any way? Yeah, it's certainly relevant. I think, as I said, all of the numbers have come in on the soft side, better than expected inflation number as well.

And that buys policymakers a bit of time to wait and see, as you say. But given rising inflation expectations, given pipeline cost pressures, our view remains that the Bank of England will still be forced to tighten monetary policy at some point. We continue to expect 50 basis points of rate hikes this year.

Market pricing had been a little bit more, but it's kind of converged around that mark this week following the soft data. But yeah, as you say, I think the question of timing is very valid now. Our kind of previous assumption was that the Bank of England would want to be proactive and try to get ahead of the curve to kind of reduce the risk of having to play catch up later on.

But we're not hearing much urgency from policymakers. I think the soft macro backdrop and the inflation number, like I said, it kind of buys a little bit more time. I was listening to Governor Bailey and others speak this week, and it seems that there is kind of recognition that tighter financial conditions on the back of rate hike expectations, you know, that's already doing some of the work for the Bank of England here.

But at some point, that needs to be backed up by policy action. And so we do think that the Bank of England will have to act at some point. In terms of timing, yeah, the next meeting in June looks too soon, I think.

But a hike at the July meeting when we get new macro projections. Yeah, I think it's a close call, but I think it's more likely than not at this point. How do you see it?

Yeah, like definitely look at the market reaction this week. It's pretty clear that the rate market in the UK has moved to scale back future rate hikes from the Bank of England. There's now about 50 basis points of hikes fully priced in by year end, which is now kind of more in line with our own kind of in-house view for 50 basis points of tightening this year from the Bank of England.

That is down from about 50 to 75 basis points of hikes that were priced in at the end of last week. And like Henry said as well, definitely the market is a lot more confident now that the Bank of England will leave rates on hold at next month's meeting. The timing of the first hike kind of pushed out a little until the July policy meeting.

See by that point in time, like we say, there should be more evidence there of the potential upside inflation risks, which gives the Bank of England the nudge to start kind of modestly tightening policy. And I think for kind of the gilt market, particularly at the long end of the curve, the dovish repricing that we've seen at the short end of the curve this week in response to the economic data, that's definitely helped to bring down yields at the long end of the curve. Going into this week, I think there were kind of two reasons why we thought the long end of the curve in the gilt market was being hit hard.

One was the kind of fears that inflation was more persistent in the UK and that another energy price shock could even worsen that scenario for the UK economy. But like we saw this week, some of the inflation data did help to ease some of the concerns over persistent inflation risks, at least before the latest energy price shock really hits the economy. The other reason why obviously the long end of the curve in the UK has been hit hard last week was the political developments in the UK.

And this week we've seen some, definitely some kind of reassuring comments from a spokesperson from Andy Burnham, who is the front runner to become the next prime minister if he can win the by-election. One of his spokespersons said earlier this week that Burnham would stick to the government's fiscal rules, which are currently kind of constraining the government's ability to borrow more to invest and spend. So if he sticks to those rules, then that definitely would limit how much further he can lose in fiscal policy if he does become the next prime minister.

So for kind of gilt holders, that's definitely a positive signal and helps ease some of the downside risks. And it does show as well, I think, that the gilt market does have the ability to kind of discipline politicians. Definitely since we had the Liz Truss mini budget shock a number of years ago, that negative gilt market reaction has forced politicians in the UK to water down some of their fiscal policies.

And it definitely looks like even at this early stage, Andy Burnham is already starting to feel some of the heat from the gilt market. So that's definitely a good sign for the gilt market. Having said that, though, obviously, we still have these lingering political uncertainty.

Prime Minister Starmer's future is still very much in the air, so to speak. And if we do see a change in leadership of the Labour Party, it is likely to shift more to the left. So it's not like those risks of losing fiscal policy have completely gone away.

But at least for now, those reassurances on the fiscal rules are definitely helping the gilt market and the pound. Be interesting to hear some of your thoughts as well as on the latest kind of political developments here in the UK, Henry. Yeah, I mean, absolutely.

I think you've covered it very well. I think to me, it seems as though the energy pricing and kind of inflation risks are the main drivers for the markets. But I think political uncertainty has the scope to amplify volatility in the UK over coming months.

It's clear it's a very high stakes by election on the horizon. If Burnham wins that, and he's not a sheer win by any means, but if he does win, then I would expect his path to number 10 would clear. And it's plausible that he could be UK prime minister by the summer.

And yeah, as you said, markets are wary about a shift toward a looser fiscal policy. In that case, Burnham is seen as being more on the left of the Labour Party and less market sensitive than Prime Minister Starmer and Chancellor Reeves. But yeah, as you said, he's pragmatic and the Liz Truss episode has clear lessons.

So yeah, lots of uncertainty. And I think UK politics is certainly going to remain a key risk theme going forward. Well, thanks, Henry.

Yeah, and definitely in terms of our outlook for the panel, like definitely this week, we have seen a relief rebound for the pound. But we don't think this kind of upward momentum will be sustained. We still think on balance that going forward, definitely into the summer period, that the risks are more skewed to the downside for the pound.

If we see further evidence emerging that the UK economy is starting to slow more in response to the energy price shock, like we started to see this week with the PMI data, if that continues, we would expect that to feed through to a weaker pound as we head into that summer period. So that kind of brings an end to today's podcast. I want to say thank you to Henry again for joining the podcast and to all our listeners, have a good week ahead. from the Global Markets Research Team.