Double-edged risks rule the UK macro scene

Markets have crossed into the second half of the year facing a fast-changing backdrop: inflation is in flux, geopolitical tensions are mounting and global central banks are marching in different directions. In the UK, a thorny domestic picture - stubbornly high inflation, a softening labour market and a sharp slide in retail sales - is colliding with global forces that are increasingly steering FX and rates. One-way trades are history; two-way risk is back with a vengeance.

Bank of England: paused, yet nowhere near the finish line

In June, the Bank of England held the Bank Rate at 4.25% as expected. Hopes of an imminent easing cycle were tempered by a cautious, data-driven tone from the MPC. Any future cuts hinge on a cooling jobs market: Governor Bailey anticipates wage growth will drop sharply in 2025, but he needs proof that slower pay is feeding into lower inflation before acting.

May’s CPI print underlined the challenge. Headline inflation stuck at 3.4% - well above the 2% target - while services inflation eased only marginally to 4.7%. Core goods and food prices remain sticky, and recent tax increases, notably higher employer NICs, appear to be sneaking into consumer prices.

External pressures threaten to rekindle price growth. Brent crude is up roughly 14% amid the Israel-Iran conflict, and UK analysts are watching gas prices even more closely. While the situation appears to be stabilising, if tensions flare and Iran obstructs the Strait of Hormuz, energy costs could spike on a scale to rival - or exceed - 2022. Some forecasters now see CPI cresting near 4% in Q3, twice the BoE’s goal.

Markets still pencil in two cuts by year-end, but that path is anything but certain. Persistent - or resurging - inflation could force traders to price back in tightening, a scenario few considered only months ago. Conversely, a deeper wobble in jobs and demand could nudge the BoE into faster easing. For now, it is a true two-way street.

FX: From rate gaps to regime shifts

In the FX world, old reliables are fading. Rate differentials matter, but geopolitics, fiscal risks and structural themes matter more.

The dollar is still the global yardstick, yet its safe-haven shine looks tarnished by erratic policy swings and an ever-larger debt pile. The euro is a tentative beneficiary of the hunt for large, liquid, rules-based alternatives - though it has its own baggage.

Sterling sits in the crosswinds. Elevated nominal yields and post-election political stability lend support, but broader FX trends are increasingly set offshore. In a risk-centric world, rate spreads alone no longer steer the pound.

Two-way risk is the new normal

The UK is emblematic of the broader global story: inflation is easing, just not quickly enough; growth is cooling, but not conclusively; policy-makers are threading a needle in choppy seas.

Across rates and FX, the message is clear: prepare for movement in either direction. Markets may still lean towards modest BoE easing, yet sticky prices, firm wages and geopolitical shocks could stall or reverse that course. Likewise, after the dollar’s 2025 retreat, shifting structural tides could propel the euro - or another contender - still higher.

For sterling, the outlook remains murky. Domestic signals are cloudy, and the bigger drivers lie abroad. In this new regime, flexibility - and respect for risk on both sides - will be vital.