Pound Sterling Exchange Rate Squeezed Oil Prices And Inflation

The pound sterling exchange rate weakened because the UK's economic growth is likely to be burdened by rising oil prices and inflation rates amid the Russia-Ukraine war.

Yesterday's publication of UK inflation data showed figures that exceeded consensus estimates, thereby reinforcing expectations of a Bank of England (BoE) interest rate increase. However, the pound sterling exchange rate actually weakened because the UK's economic growth would likely be weighed down by rising oil prices and the excessively high inflation rate amid the Russia-Ukraine war.

Also Read : BOJ Minutes: Japan's Inflation Will Exceed Central Bank's Target

When the news was written at the end of the Asian session on Thursday (24/March), GBP/USD was under pressure around 1.3200. Sterling also slumped versus the Japanese yen although still ahead against the euro which was more affected by Russia's action.

Pound Sterling Exchange Rate Squeezed Oil Prices And Inflation

GBP/USD Daily chart via TradingView

The West-Russia Dispute Is Sticking Out

US President Joe Biden landed yesterday in Brussels for a meeting with European officials. One of the agenda items discussed at the meeting was related to plans to apply further sanctions on Russian energy exports.

The US urged European countries to immediately reduce their dependence on energy supplies from Russia. Meanwhile, the European side notes that the European Union collectively maintains closer trade relations with Russia than the US, so it is more sensitive to the derivative effects of continued sanctions against Russia.

Also Read : US Dollar Surges, Spurred by Powell's Speech and Ukrainian Tempest

Russian President Vladimir Putin said yesterday he would demand payment in rubles for the sale of his gas to "unfriendly countries". The list of "unfriendly countries" to Russia includes the US, UK, Japan and European Union member states. As a consequence, local gas prices immediately skyrocketed again. The price of crude oil on the international market also skyrocketed again until Brent reached more than USD 120 per barrel.

"WTI and Brent are both rising strongly again," said Chris Beauchamp, chief market analyst at IG, "Today seems to be a resurgence of war fears, driving up oil prices while European markets fell sharply."

Expensive commodity prices and declining stocks are among the factors that commonly put pressure on the pound sterling exchange rate. The pound sterling has the potential to strengthen if the Russian-Ukrainian negotiations reach a certain agreement, but the current situation is still difficult to predict.

UK Standard of Living Potentially Drops

Britain actually does not have a high dependence on Russia's energy supply. Barclays notes that more than 80% of UK natural gas imports come from Norway and only 15% comes from Russia. This indicates that the energy crisis experienced by the UK will not be as bad as its European counterparts. However, the impact remains.

The Office for Budget Responsibility (OBR) yesterday announced a cut in its forecast for future UK GDP growth. The institution, which is funded by the UK's Ministry of Finance, lowered its growth forecast from 6.0% to just 3.8%, while inflation is likely to average 7.0% for this year. The real standard of living in the UK will fall by 2.2% in 2022-2023, aka scoring the worst fiscal year in recorded history.

Also Read : Disappointing Central Bank Announcement, GBP/USD Threatened

An increase in inflation is usually followed by an increase in the central bank's benchmark interest rate. However, an increase in interest rates amid the current situation could exacerbate the economic slowdown. Therefore, some analysts have begun to voice doubts about the prospect of a "BoE rate hike" this year.

"The fiscal consolidation that will hit the economy in April remains so strong that we expect the recovery in real household spending to almost stall and the MPC (BoE) will refrain from raising interest rates this year as quickly as the market expects," said Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.

Pantheon Macroeconomics expects just one more 25 basis point BoE rate hike this year. In line with the disappointment of the market which had already predicted a bigger interest rate increase, they also considered that the GBP/USD exchange rate has the potential to retreat to 1.28.