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Following the start of Operation Epic Fury, GBP (-1.9%) was more resilient than the EUR (-2.2%) and CHF (-3.8%) in March.The UK was slightly more insulated from the global energy shock. Only about 1% of the UK’s gas supply comes from Qatar via the Strait of Hormuz. The UK relies heavily on its own North Sea production and pipelines from Norway. The EU is far more exposed, with roughly 12-13% of its LNG coming through the Strait. When Hormuz was effectively closed in February, the EU had to scramble to compete for more expensive US cargoes. As a landlocked nation, Switzerland relies on transit through the EU, with its economy vulnerable to energy shocks that hit Germany and France.
In April, GBP (+2.9%) outperformed the CHF (+2.3%) and EUR(+1.5%). The Bank of England has the same policy rate level as the 3.75% Fed Funds Rate, compared to the European Central Bank’s 2%, and the Swiss National Bank’s 0%. While not as physically vulnerable to the Iran conflict, the UK was not immune to headline inflation, which increased to 3.3% YoY in March, well above its 2% target. Not surprisingly, markets bet that Europe’s central banks would hike rates before the Fed, driven by US President Donald Trump’s expectation for his Fed Chair nominee, Kevin Warsh, to lower rates when he assumes office on May 15(tomorrow). Trump also pushed for “ceasefires” that raised hopes for a diplomatic off-ramp to the Iran conflict at his official summit with Chinese President Xi Jinping today. 
However, GBP (-0.6%) underperformed the EUR (-0.2%) and CHF(-0.1%) in the first half of May. Markets now see GBP facing a reality check as focus shifts from the US-Iran conflict to 10 Downing Street. British Prime Minister Keir Starmer is facing significant internal pressure to resign following the ruling Labour Party’s heavy losses at the local elections and a subsequent wave of resignations, including junior ministers and parliamentary aides. Markets now see the BOE delaying its policy rate hike to July vs. the previous expectation of a rate hike with the ECB in June.
In the end, the GBP’s outlook remains tethered to the escalation or resolution of the Iran conflict, primarily because of how it dictates the USD’s strength. Despite lowered expectations, the market has not ruled out today’s Trump-Xi summit as a turning point for an off-ramp. Trump’s consistent preference for lower interest rates often aligns with a weaker USD to boost US exports, but the inflationary pressure from the Iran war makes it difficult for Warsh to justify aggressive rate cuts. US Treasury Secretary Scott Bessent’s visit to Japan appears to prioritize stability over competitive devaluation, as he aligns with Japan in avoiding disorderly currency volatility. History shows that domestic UK politics drives GBP when it threatens fiscal solvency in a major way, such as Lizz Truzz’s mini-budget crisis in 2022. Like it or not, GBP is still holding on to its post-Operation Epic Fury appreciation, in contrast to EUR and CHF.
Quote of the Day
“Good people do not need laws to tell them to act responsibly, while bad people will find a way around the laws.”
Plato
May 14 in history
In 1955, the Soviet Union and seven Eastern Bloc nations signed the Warsaw Pact, a mutual defence treaty formed in response to West Germany’s integration into NATO.
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