UK Data Complicates the Story Behind the British Pound’s Recent Rebound

Yet geopolitics alone does not explain sterling’s resilience. Another important driver has been the hawkish shift in expectations for Bank of England policy—though that support may prove fragile.

From Cuts to Hikes—A Sharp Repricing

Prior to the outbreak of hostilities, markets were positioned for a gradual easing cycle in 2026, with two or possibly three rate cuts anticipated as inflation drifted back towards target. The conflict has disrupted that narrative. A surge in global energy prices—triggered by disruptions to flows through the Strait of Hormuz—has revived concerns about inflation persistence, particularly in economies such as the UK that remain heavily reliant on imported energy.

This external shock has fed directly into rate expectations. Unlike several of its major peers the Bank of England struck a decisively hawkish tone at its March meeting on monetary policy, openly discussing the possibility of higher rates to counter resurgent inflationary risks. In response, markets rapidly repriced, at one stage factoring in as many as three to four rate hikes this year.

Markets May Have Overreached

That repricing has been a key pillar of recent pound sterling resilience. Higher expected rates, especially relative to other advanced economies, tend to support currencies. However, there are growing signs that markets may have moved too far, too quickly. Bank Governor Andrew Bailey has since pushed back against the notion that rate hikes are imminent or inevitable, highlighting the uncertainty surrounding both the duration of the conflict and the scale of the associated price shock.

Growth: Strong Start, Weaker Outlook

Domestic data reinforces this more cautious interpretation. On the surface, the UK economy entered the current period on a relatively firm footing. February GDP surprised to the upside, expanding by 0.5% month-on-month, suggesting some newfound resilience heading into the shock. However, growth expectations for 2026 have since been slashed, with the UK receiving the largest downgrade out of all major economies in the IMF’s latest World Economic Outlook, reflecting the country’s vulnerability to higher energy costs. While the revised forecast of around 0.8% growth is broadly in line with other major European economies, it marks a loss of relative momentum that had previously supported sterling.

Inflation Edges Higher, But No Shock

More recent data presents a mixed picture, but one that ultimately complicates the case for sustained monetary tightening. Inflation rose to 3.3% in March, interrupting the previous gradual decline and underscoring the early effects of higher input costs related to the conflict. However, the increase was broadly in line with market expectations and, importantly, not materially worse. For policymakers, this reduces the urgency of an immediate response.

Growth is the other side of the coin. Many euro-area economies still rely heavily on exports to offset weak domestic demand. A stronger currency makes European goods less competitive abroad, potentially squeezing margins and weighing on activity just as the recovery is finding its footing. With the two effects taken together, and sustained over time, they could start to shift the balance of risks in a way that matters for policy.

It is here that the euro’s recent strength becomes more than a market curiosity. In an extreme scenario, prolonged currency appreciation could force the ECB to reconsider its comfortable stance, reopening the door to rate cuts not because of a deterioration in fundamentals, but because external forces are quietly doing the tightening for it.

Labour Market Signals Softness

In contrast, labour market dynamics point more clearly towards underlying weakness. The recent fall in the headline unemployment rate to 4.9% is misleading, driven largely by a contraction in labour force participation rather than stronger hiring. Meanwhile vacancies have declined to their lowest level since early 2021, while wage growth has cooled to post-pandemic lows. Together, these indicators suggest that both firms and households are becoming more cautious, dulling the prospects of the economy.

This matters for monetary policy. A softer labour market reduces the risk of so-called second-round inflation effects, where an initial, externally driven inflation shock feeds into persistently higher wages and domestic prices. Indeed, this argument has been central to the more dovish voices on the Monetary Policy Committee, including Bailey himself. Compared to the 2022 energy crisis, the UK economy is now starting from a weaker position, and policy is already restrictive. This combination potentially limits the need, and the scope, for further tightening.

A Delicate BoE Balancing Act

The implication is that while inflation risks have risen, the case for aggressive rate hikes is far from settled. The Bank of England faces a delicate balancing act: responding to an external price shock without exacerbating an already slowing economy. In this context, a cautious, wait-and-see approach appears more likely in the near-term than the assertive tightening currently priced by markets.

The upcoming Bank of England meeting on April 30 will be critical in shaping this narrative. While a decisive policy move may be unlikely at this stage, the tone of communication—and the distribution of votes within the committee—will offer important signals. The key fault line will be the perceived risk of second-round inflation effects beyond the current shock. If policymakers emphasise labour market weakness and downplay these risks, expectations for rate hikes could be pared back sharply.

Sterling At a Crossroads

The currency’s recent strength has been built on the assumption of a more hawkish policy path. Any shift away from that view—whether driven by softer data, more cautious central bank guidance, or an easing in energy prices—could trigger a reversal. Conversely, a prolonged conflict and sustained upward pressure on inflation would keep tightening expectations alive, providing continued support.

For now, the balance of risk suggests that markets may have overestimated the Bank’s willingness to tighten policy in response to this shock. As that realisation sets in, sterling’s recent performance may prove difficult to sustain.