Sterling Rally Driven by Hawkish Policy Path

Sterling's rally has been underway for some time, driven by central bank signaling and an increasingly hawkish policy path from the Bank of England. Before today's stronger-than-expected UK GDP data, markets were already assigning a high probability to a November BoE hike and implied terminal rate near 4.86%.

The sequence matters: Bank of England Governor Andrew Bailey first highlighted the difficulty of maintaining unchanged policy in the face of persistently high energy prices, followed by Deputy Governor Dave Ramsden's explicit leave open for another hike if upside inflation risks keep building. Sterling rebounded from recent lows as markets moved aggressively toward a November increase.

The revised GDP numbers give the BoE hawks more room to argue that the economy can withstand tighter policy. UK GDP growth in Q2 was revised from 0.4% to 0.5% q/q, with growth leaning heavily on net trade and household consumption increasing only 0.3%. That makes the GDP beat supportive, but not a picture of uniformly strong domestic demand.

The same energy-price shock driving the BoE toward a more hawkish stance is also threatening household purchasing power and increasing pressure on public finances. Economists warn that the resilience visible through the first half may fade into Q4 as inflation erodes real income growth and the government faces pressure to tighten fiscal policy.