In worrying times like this, it is important for us to point out that we completely acknowledge the wider implications of international conflict. Our principle duty as a company is to ensure that our clients are aware of all of the factors that affect currency exchange rates, which sadly sometimes includes war. Our thoughts are with everyone who is being affected by this escalating situation, and our currency updates do not intend to diminish, ignore or undermine the true impacts of this conflict.
The pound to US dollar exchange rate has consolidated (it is not going up or down) as markets are cautiously optimistic, while there is renewed demand for the US dollar. In regards to a May rate hike, BoE Governor Andrew Bailey said on Monday that the situation is very volatile after Russia's invasion of Ukraine pushed energy prices higher. However, the positive change in risk sentiment appears to have helped the pound to US dollar exchange rate early Tuesday.
Bank of England Governor Andrew Bailey’s speech
The pound dropped following Bailey's comments on the pound and economic outlook. While speaking at a virtual event on Monday, the Governor of the BoE, Andrew Bailey, noted that they need to be very cautious on the forward guidance language as there is increased uncertainty about Britain’s economic outlook with evidence of an economic slowdown in business and consumer surveys.
When he was asked about the possibility of another rate hike in May, he responded by saying "the situation is very volatile.” The risks for inflation were two-sided, he said, as it could either slow or accelerate more than the BoE has projected.
He also said that the shock to inflation-adjusted incomes in Britain due to higher energy prices will be bigger than in any year in the 1970s. He stated: “This really is an historic shock to real incomes. The shock from energy prices this year will be larger than every single year in the 1970s.” After the start of the war in Ukraine, oil and gas prices surged, pushing inflation higher and adding to the painful squeeze on family incomes in the UK.
Bailey warned that the increased volatility seen in commodity prices means that financial markets’ resilience cannot be taken for granted and central authorities are monitoring the situation. As he noted: “Liquidity conditions have deteriorated in many commodity markets, margining costs have risen, which is of course a reflection of much higher volatility and risks in these markets. We can't take resilience in particularly in that part of the market for granted. There's a strong need to work together on this.”
Bank of England and rate hikes
The Bank of England’s dovish 25bp hike in March is likely to set a more controlled tone for the pound in the coming weeks, and economists expect the BoE to deliver three more 25bp hikes this year. HSBC economists have said that “the shadow cast by the BoE meeting over the GBP will persist in the coming weeks, especially if BoE members continue their dovish refrain.” They added that “With higher energy prices, along with other inflationary factors, we now see UK CPI inflation running at close to 8% for the rest of 2022 and expect the BoE to deliver a 25bp hike in each of the next three meetings, taking the policy rate to 1.50% this year. However, this remains considerably more dovish than the market curve. As such, risks to the GBP are skewed to the downside.”
The pound was supported by positive risk on market sentiment due to hopes that there will be progress in the Russia-Ukraine peace talks. This has limited gains for the US dollar and helped the pound. The market’s focus will remain on fresh developments surrounding the war in Ukraine and any headlines will impact on market sentiment.