Pound Climbs to Two-Week High as Bailey Dismisses Talk of a Rate Hike 'Secret Plan'

The pound edged towards two-week highs against the dollar on Wednesday, shrugging off a rally in oil above $100 a barrel as the conflict in the Middle East widened. Sterling was last a touch stronger on the day at $1.3545, its highest since August 28.

The move came a day after Bank of England Governor Andrew Bailey pushed back against the idea that a rate hike is inevitable. "What I want to dispel is the idea that we've really got a secret plan, we know where we're going to go to and it's unconditional," he said at a hearing before lawmakers in parliament.

Energy prices turn up the heat

Crude is now 40% above where it traded before the war began at the end of February, and European natural gas prices are around three times higher. That combination is putting central banks under pressure to raise interest rates, and Britain is especially reliant on energy imports.

Consumer inflation picked up to 2.9% in July, from June's 15-month low of 2.6%.

What the market is pricing in

Money markets show traders do not expect the Bank of England to raise interest rates when it meets next week. But at least two hikes are priced in by next March, with a 40% chance of a third by then. The Federal Reserve, by contrast, is only expected to raise rates twice by that point, according to the rates market.

Sterling has been one of the better performing major currencies against the dollar this year, with a gain of 0.5%. The euro has dropped 1% over the same period, while the yen is down 2%. Much of sterling's tailwind has come from the expectation that the BoE will have to raise rates, especially with growth holding up.

ING says the rate bet looks overdone

Economists and analysts are at odds with the market, as is Bailey. ING strategists argue there is good reason to link higher energy prices to the rate outlook. Since the start of the Iran war, every $10 increase in Brent has added around 15 basis points to two-year rates in Britain, compared with 11 basis points for euro zone rates and 8 basis points for US rates.

ING strategist Michiel Tukker said the British rate outlook as reflected by the market appears overdone. But the level of uncertainty around the oil price and the fiscal risks ahead, starting with the Autumn Budget next month, complicate the prospects for the pound itself.

"Only once the predictability of oil prices improves do we see scope for tactical opportunities. But with oil likely to test $100 again, we stay on the sidelines," Tukker said.