Bank of England Deputy Governor Sarah Breeden said it was “not at all obvious” there is a path towards lower energy prices, and warned that if the shock proves larger or more persistent, monetary policy may need to respond. She said the indirect pass-through from higher energy costs has so far been limited, a pattern she linked to slack in the UK economy, but added that the balance of risks has shifted and a central bank response would become more likely if those risks crystallise. Breeden also cautioned policymakers cannot wait too long for conclusive evidence of second-round effects on prices.
Breeden said she focuses on what firms report about their pricing decisions, and pointed to the BoE’s DMP survey, the PMI and the Bank’s agents’ survey as key inputs. Markets showed limited reaction: sterling stayed under pressure, with GBP/USD down 0.12% on Thursday and trading around 1.3220 at the time of writing.
—Energy Volatility and Interest Rate Implications
We are closely monitoring the persistent volatility in global energy markets, which threatens to keep UK inflation pressures elevated. Recent market data shows that European natural gas benchmarks have experienced renewed fluctuations, directly impacting domestic energy costs as we enter the colder autumn months. Because of these stubborn supply-side pressures, we must prepare for the possibility that monetary policymakers will feel forced to raise interest rates to prevent deeper economic damage.
In the interest rate derivatives space, we believe it is wise to adjust positions in Sterling Overnight Index Average (SONIA) futures to reflect a tighter policy outlook. With the risk of second-round inflation effects growing, continuing to price in aggressive rate cuts for the remainder of the year looks increasingly risky. Consequently, we should look at shorting near-term rate contracts or utilizing payer swaps to hedge against a sudden upward shift in the yield curve.
—Sterling Volatility and Business Sentiment Signals
The British Pound has already felt the pressure, with the GBP/USD pair trading down around the 1.3220 level as markets digest these energy risks. To navigate this volatility, we can look at buying short-dated GBP put options to protect against further downside in the currency. Additionally, with currency volatility measures remaining relatively soft, option premiums present an affordable way to position for sudden sterling weakness.
We must also closely watch upcoming business sentiment indicators, specifically the Decision Maker Panel (DMP) survey and the Purchasing Managers’ Index (PMI) data. These reports will tell us if businesses are starting to pass higher energy costs directly onto their customers through their pricing decisions. If these indicators point to rising selling prices, we should expect a rapid and sharp repricing of interest rate expectations in the swap markets.
