Pound rises near four-week high as oil retreat eases pressure on UK rate outlook

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Pound nears four-week high

Highlights

Pound rises 0.1% to $1.34, extending a rebound of over 2% since late June seven-month low amid easing oil prices.
Traders now price in one Bank of England rate hike for 2023 with only 25% probability of a second, down from three hikes expected weeks ago.
Sterling volatility reaches 6%, second only to euro, as leadership uncertainty and macroeconomic shifts weigh on currency markets.

Currency moves and rate expectations

As reported by Reuters, the pound is up 0.1% on the day at $1.34, extending a rebound of more than 2% since a seven-month low in late June after Labour Prime Minister Keir Starmer announces he would step down.

Britain is more dependent on energy imports than many of its neighbours, leaving UK markets more sensitive to sharp swings in oil prices. With oil falling from peaks above $120 a barrel in May, traders now see a much lower chance of the Bank of England delivering as many rate hikes this year as previously expected.

Money markets show investors still price in at least one BoE rate increase this year, while the probability of a second stands at about 25%. A few weeks ago, as many as three hikes are priced in at one stage.

BNY says energy-driven supply shocks could still support sterling at the margin because the UK stock market includes heavyweight oil and gas companies that would benefit if crude prices accelerate again. Its strategists say domestic purchases remain consistent due to positive real rates, while international demand is holding back the pound because of concerns over growth and politics.

Political uncertainty adds to volatility

Sterling is more volatile than most other major currencies this week, partly because of uncertainty over who Andy Burnham, seen as the UK's next likely prime minister, may choose as finance minister.

Overnight implied volatility, a gauge of demand for protection against sudden moves in the pound, is around 6%, second only to the euro at 6.5%. The recent increase in volatility highlights how currency traders are balancing macroeconomic shifts with domestic political risks.

The pound is also strengthening on a broader basis in recent weeks. The euro is steady at 0.853 pounds on Thursday and remains near its weakest level against sterling in a year, while the Japanese yen is close to its lowest level versus the pound in more than 18 years.

In our earlier article on oil’s pullback after a Middle East-driven rally, we noted that crude turned lower after U.S. strikes on Iran sparked fresh fears of supply disruption around the Strait of Hormuz. We also explained that even a limited threat to Hormuz can quickly lift freight and insurance costs, keep a geopolitical premium in prices, and ultimately feed into inflation expectations that matter for central banks and currencies.

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