Sterling rose last week, sending EUR/GBP down to a fresh low of 0.8649. Markets have shifted towards a more hawkish Bank of England outlook, linked to firmer UK growth early this year and underlying inflation staying high.
The note expects the Bank of England to keep rates on hold this week, with two Monetary Policy Committee members voting for a rise. It names Chief Economist Huw Pill and Catherine Mann as the two expected to back a hike.
Market Drivers And Recent Price Action
Higher UK rate expectations have supported the pound, while higher energy prices and domestic politics have acted as headwinds. Political risks linked to Prime Minister Keir Starmer’s leadership, and the approach of local elections, are flagged as possible triggers for a temporary fall in sterling in the coming weeks.
We see the Pound is performing well, pushing EUR/GBP down towards the 0.8650 level. This strength comes from markets anticipating the Bank of England will maintain a hawkish stance due to a resilient UK economy. Looking back at early 2025, persistent inflation was the primary concern driving this view.
Reviewing the data from that period, UK inflation was indeed proving stubborn, with the Consumer Price Index (CPI) in the first quarter of 2025 holding firm above 3%, a full percentage point over the Bank’s target. This was happening as GDP figures showed the UK narrowly avoided a technical recession, posting slight positive growth. These factors combined made the case for higher interest rates much stronger than previously thought.
For derivative traders, this creates a clear tension between supportive monetary policy and political headwinds. The risk of a temporary sell-off, tied to uncertainty around Prime Minister Starmer’s leadership, suggests buying short-term GBP put options. This strategy provides a hedge, allowing traders to protect their positions from a sudden drop in the Pound’s value.
Options Volatility And Trading Implications
The focus on the upcoming local elections in May 2025 was a known catalyst for this potential volatility. We would expect the implied volatility on EUR/GBP options to increase as we approach that date, making options more expensive but also more valuable for hedging. This environment favours strategies that can profit from sharp price swings.
The expectation of a divided “hawkish hold” from the Bank of England, with dissenters voting for a rate hike, signals significant internal debate. This division underscores the Bank’s reluctance to ease policy, which should limit the downside for the Pound. Therefore, any politically driven dips could be seen as buying opportunities, assuming the economic data remains robust.
