Rates Spark: Sterling’s hawkish pricing still looks overdone
The desk believes that the current market pricing for UK interest rates is overly hawkish compared to the guidance from the Bank of England (BoE) and the underlying macroeconomic fundamentals. Per the full note from ing-think, recent commentary from BoE Governor Andrew Bailey suggests skepticism towards the expectation of multiple rate hikes within the next year, as market participants appear to be factoring in an implicit risk premium rather than reflecting genuine policy shifts. The sensitivity of UK rates to fluctuations in oil prices further complicates near-term trading perspectives, with a noted increase in Brent crude prices contributing approximately 15 basis points to 2Y rates, exceeding increases in EUR and USD counterparts.
What the desk is arguing
The desk suggests that UK interest rates are priced for a series of hikes that may not materialize in the way markets expect. This perspective is grounded in remarks from BoE Governor Andrew Bailey, who recently opposed the idea of frequent hikes as priced into the GBP curve. The implication that market pricing is too aggressive aligns with our structural bullish outlook, albeit with caution about near-term trading intricacies.
Notably, the desk highlights that UK rates exhibit substantial sensitivity to oil price fluctuations, where a $10 increase in Brent has historically led to a rise of around 15 basis points in 2-year yields. This suggests that oil-related volatility could serve as a significant driver for the GBP rate movements, complicating otherwise bullish outlooks for sterling.
The counterfactual being implicitly rejected here includes the notion that the market's anticipation of multiple hikes reflects a fundamental shift in policy rather than a risk premium related to external factors, such as geopolitical developments affecting oil prices.
Where it sits in our coverage
Our consensus target for GBP/USD sits at 1.075, with a range of 1.04 to 1.12. Specifically, firms are positioned as follows: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This desk's perspective diverges from bofa, which takes a more cautious stance, pricing the pair lower than the market consensus, while aligning more closely with jpmorgan, reflecting a bullish stance yet mindful of potential complications.
How other firms see it
Overall, firms like jpmorgan support a bullish view on sterling as they align with the potential for strong UK growth driving rate increases. Conversely, bofa expresses concern over economic stability, leading to a less optimistic outlook.
Market participants should watch the dynamics of the GBP/USD response to ongoing geopolitical tensions that may influence oil prices as they interact with BoE guidance, noting that fluctuations may impact rate expectations significantly.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Current GBP rate pricing reflects an overly hawkish outlook compared to BoE guidance.
- 02BoE Governor Andrew Bailey has emphasized caution regarding expectations for multiple rate hikes.
- 03Sterling rates exhibit high sensitivity to oil price movements, complicating near-term trading strategies.
- 04Fiscal uncertainty surrounding the Labour government could further impact rate movement.
Market implications
The desk suggests monitoring the GBP/USD level around 1.075, which sits near our consensus target. Additionally, market reactions to oil price fluctuations could provide additional insight into the efficacy of rate hike expectations moving forward.
Risks to this view
A shift toward more aggressive fiscal expansion by the Labour government could delay expected BoE cuts and potentially catalyze market recalibrations, thereby invalidating the current call for a more tempered rate outlook.
Articles Rates Spark: Sterling’s hawkish pricing still looks overdone Published 07:20 Rates Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download UK rates look too hawkish relative to Bank of England guidance and macro fundamentals. But oil sensitivity and fiscal uncertainty are sustaining a sizeable risk premium, complicating the near-term expression of our structurally bullish view Michiel Tukker Bank of England Governor Andrew Bailey has pushed back against the idea of multiple hikes as priced in by the GBP curve Oil price uncertainty and fiscal risks complicate an otherwise bullish structural outlook for UK rates Sterling rates continue to reflect a very hawkish narrative and seem overdone relative to central bank communications and macro fundamentals. In parliament on Tuesday, Bank of England Governor Andrew Bailey pushed back against the idea of multiple hikes as priced in by the GBP curve.
And this is not the first time the Bank of England has struck a much more dovish tone than markets' positioning. The question is whether markets are genuinely expecting almost three hikes over the next year or whether we are dealing with some form of risk premium. We think the latter.
Sterling rates show high sensitivity to oil prices, which means any bet on GBP rates is also a bet on Trump’s next move. Since the start of the conflict in the Middle East, every $10 increase in Brent added around 15bp to 2Y rates, more than the 11bp for EUR and 8bp for USD rates. In addition, the new Labour government adds budget-related risks.
We don’t expect a material fiscal expansion, but we cannot fully dismiss the probability either. More government spending would delay Bank of England cuts, and according to markets, even add more hikes. So whilst we take a structurally bullish view on sterling rates, trading this view in the near term remains a challenge.
We also believe many market players face the same issue, explaining why sterling rates seem to bear a significant risk premium. Only once the predictability of oil prices improves do we see scope for tactical opportunities. But with oil likely to test $100 again, we stay on the sidelines.
Wednesday’s events and market view There is not much data on Wednesday, in theory leaving the markets to be mostly dictated by geopolitical headlines and energy prices. On long-end US yields, the Treasury’s announcement of the 10-20y buyback operations will receive more attention. Recall, in a surprise move in August, the Treasury had announced to at least double its long-end buyback operations – a size announcement of US$4bn would thus mark the bare minimum.
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