From Cuts to Caution: What the Bank of England’s Pivot Means for the Pound

Cutting Cycle Locked In: Why Markets Were Betting Against the Pound

It wasn’t meant to be like this. Only a few weeks ago the outlook for UK interest rates – and by extension the pound – looked straightforward. Inflation was on track to return to the Bank of England’s 2% target by mid-year, and markets were increasingly confident that rate cuts were coming as soon as March, with one or two more to follow by year’s end. For an economy that has been effectively flatlining since the second half of 2025, and with unemployment edging up to post-pandemic highs, that prospect of easier policy couldn’t come soon enough.

Sterling reflected these expectations, slipping back from the four-year high reached in January at the height of the Greenland episode. The narrative was simple: weaker growth plus falling inflation equals lower rates, and a softer pound.

Energy Markets Upended: How the Iran Conflict Changed Everything

Then came the shock. The escalation of conflict involving Iran, and the resulting disruption to the Strait of Hormuz – a critical artery for around 20% of global oil and LNG supply – has sent energy prices soaring. Indeed, on the morning of the Bank’s meeting Brent briefly surged above $117 per barrel, while UK gas prices jumped 30% after the crucial Ras Laffan gas field in Qatar was hit. The parallels with 2022 are hard to ignore, and markets have been quick to reassess what this means for inflation, interest rates, and currencies.

Growth vs Inflation: The Bank of England’s Tightrope Walk

For the Bank of England, this has created a genuine policy dilemma. On the one hand, the domestic economy is weak and would clearly benefit from lower borrowing costs. On the other, higher energy prices risk reigniting inflation just as it was coming under control. Cutting rates into that backdrop could undermine the progress made on inflation; tightening policy risks worsening an already fragile growth picture. Faced with that trade-off, the Bank chose to pause, voting unanimously to hold rates at 3.75%.

A Hawkish Hold: Why the Bank Chose to Wait

For sterling, this “wait and see” decision has been anything but neutral. In fact, the pound rallied in the immediate aftermath of the announcement. Why? Because the tone of the Bank’s communication leaned more hawkish than markets had anticipated. Not only were rate cuts pushed into the distance, but policymakers also openly discussed the possibility of rate hikes if inflation pressures prove more persistent.

In FX markets, currencies are driven as much by expectations as by actual policy moves. The move from pricing in imminent rate cuts to contemplating rate hikes represents a significant repricing of the UK rate outlook, providing near-term support for the pound.

Two Paths: Temporary Spike or Lasting Inflation Shock

However, it would be a mistake to view this as an unambiguously positive story for sterling.

Much hinges on how the energy shock evolves. If the disruption to the Strait of Hormuz proves short-lived, and prices retrace in the coming weeks, the inflationary impact may amount to little more than a temporary spike. In that scenario, the Bank could resume its previous path, with rate cuts back on the table later in the year. For the pound, that would likely mean renewed downward pressure as rate differentials move against it.

But if the conflict drags on, the risks become more troubling. Sustained higher energy prices would feed into transport, food, and household bills, raising the prospect of “second-round effects” where businesses pass on costs and workers demand higher wages, fuelling a wage-price spiral. A delayed policy response in 2022 meant the UK was particularly exposed to this dynamic, and policymakers will be keen to avoid a repeat.

In that environment, the Bank may be forced to keep rates higher for longer, or even tighten further, despite weak growth. While higher rates can support a currency in theory, if they exacerbate an already struggling economy, investor confidence in UK assets could deteriorate, ultimately weighing on sterling.

Nonetheless, the bar for rate hikes remains high. Unlike in 2022, policy is already restrictive, and the economy lacks the tailwinds of a post-pandemic rebound or tight labour market. Attention now turns to the Bank’s April 30 meeting, alongside an updated Monetary Policy Report, for clearer guidance on the outlook.

Weak Growth, Fiscal Pressures: The Pound’s Underlying Fragility

There are also fiscal considerations lurking in the background. A prolonged energy shock may prompt government intervention in the form of renewed household or business support. While politically understandable, such measures would come at a cost. Any erosion of the UK’s fiscal position risks unsettling gilt markets – something we have already seen hints of in recent sessions – and that, in turn, can spill over into currency weakness.

Volatility Ahead: Next Moves Depend on Global Forces

So where does this leave the pound? In the near term, sterling is being supported by a repricing of interest rate expectations. The Bank of England’s hawkish tilt has given the currency a lift relative to peers where central banks have struck a more circumspective tone.

Looking slightly further ahead, however, the outlook becomes less clear. The pound is now caught between two competing forces: the support from higher-for-longer interest rates, and the drag from a weak domestic economy facing a renewed external shock.

Ultimately, the balance will depend on factors largely outside the Bank’s control – most notably the trajectory of the conflict and energy prices. It will also depend on how convincingly UK policymakers can navigate the trade-offs between inflation and growth, and whether businesses and households can weather another period of heightened uncertainty.

For now, the key takeaway is that sterling is likely to remain sensitive to incoming headlines. What looked like a straightforward easing cycle has turned into a far more complex and fluid situation. Volatility – rather than direction – may be the defining feature of the pound in the weeks ahead.