Pound Sterling Strengthens Against Euro and Dollar on Rising Oil Prices

The British pound is experiencing gains against both the euro and dollar due to increased oil prices. This development has led to higher UK inflation expectations, which in turn raises the likelihood of a Bank of England rate hike.

Oil prices are above $107 per barrel after President Donald Trump rejected an Iranian proposal to reopen the Strait of Hormuz within seven days. The rejection sparked a surge in Brent crude, putting upward pressure on sovereign bond yields.

The relationship between oil prices and the pound-to-euro exchange rate is driven by two channels: the Eurozone's larger manufacturing base makes it more exposed to energy shocks, and higher oil prices lift UK inflation expectations, increasing the odds of a rate hike and pushing up gilt yields that attract capital into sterling.

UK money markets attach an 80% probability to a November rate hike, with close to three further quarterly hikes priced beyond that. The uncertainty surrounding the fiscal outlook, including the Labour Party conference's spending commitments and potential changes to benefit payments, is expected to limit pound upside.