Sterling will continue to rise in the coming months, analysts are expecting, but they also warn a period of pause for the currency in the near term. Investors will be closely watching the release of crucial economic data this week as well as the next ones to find more evidence about the economy returning back to normality. With employment data out on Tuesday, inflation and PMI numbers out on Wednesday, and retail sales out on Friday, the current week will be a busy one.

Vaccination programme

With the vaccination rollout going smoothly and the UK being ahead of the rest of Europe, investors are waiting to see that the economy is improving. Any advances in Sterling during the coming months will be indicative of the country’s economic recovery and that the UK is exiting the pandemic in a sustainable manner due to the fast pace of the vaccine programme. Unlike the UK, Covid cases in Germany and France are rising and resulting in extended lockdown measures.

EU-UK trade deal

Also helping the pound is the renewed certainty in the government and Brexit after December’s trade deal. As economists noted, "We expect the Brexit deal will eventually reduce the uncertainty which has been weighing on especially UK businesses over many years now after the near-term adjustment to the new relationship is over. We believe Brexit has moved into the background now.” With less risks and more stability, the pound will continue to rise, however, analysts are cautioning that the currency might find it difficult to maintain its appreciation pace in the coming days and weeks. Especially, after the BoE kept a cautious tone and did not raise interest rates, despite recent positive data, markets might have already priced in the positive news and the pound might get stuck for a while. For many analysts, there is still hope, as the pound could move higher when it becomes clearer that it has exited the pandemic unscathed and strong.

In other words, the near-term pound behaviour will mostly depend on the economic data and whether there are strong numbers to boost market confidence. The coming weeks will be crucial in that regard.

UK economic data

Tomorrow, the release of UK employment data for December and inflation numbers on Wednesday will be closely watched by investors. After losing -114k jobs in November, the latest reading is expected to be disappointing indicating a loss of -170k jobs. These job losses are coming despite the extension of the furlough scheme into September.

The inflation numbers for February are expected to rise to 0.8% from 0.7% but the market will expect a higher move. A higher UK inflation number would then put pressure on the Bank of England to bring forward its rate hike plans when the economy reopens in June.

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After a dovish performance from the US Federal Reserve yesterday, investors have been waiting to see what the Bank of England thinks about the UK economy. Economists were expecting the bank to signal that it will raise interest rates, something that would help to extend the current Pound Sterling rally. However, the bank has disappointed by announcing that it will not raise interest rates until inflation is under control and has risen considerably.

The Pound has strengthened in 2021 after the bank confirmed that it won’t take interest rates into negative territory and the assumption now was for the bank to raise them and support the pound.

Bank remains cautious

However, while economic recovery and the vaccination programme have offered a positive outlook, the bank chose to maintain the current pace of quantitative easing (£4.4bn weekly) and reach its inflation target. The bank said that "The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress has been made in eliminating spare capacity and achieving the 2.0% inflation target.” After the employment fell during the pandemic the Bank expects it to recover so that rising wages start pushing inflation higher. The bank’s decision reflects a more cautious stance as it prefers to wait and see how things develop and whether inflation rises above 2.0% as employment recovers closer to pre-pandemic levels.

The pound fell as investors and traders were expecting a more hawkish tone from the bank.

Bank expectations

The Bank noted that recovery from April 2022 onwards will slow down due to the March Budget which will create a medium-term fiscal tightening. They stated that there is little hope that CPI inflation will rise above the target at the end of this year. According to Samuel Tombs, Chief U.K. Economist at Pantheon Macroeconomics: "The MPC chose not to push back against the recent rise in rate expectations and gilt yields. This was never likely, given that the first rate hike isn’t fully priced-in by markets until Q1 2023; the Committee can’t make credible commitments that extend so far into the future.” Tombs added that interest rates will be raised soon as long as the markets recover. More generally, though, the Bank of England appeared to be less gloomy about unemployment and that a more resilient than expected economy will help improve the employment landscape.

BoE: signs of economic recovery

While the Bank of England’s MPC voted 9-0 to leave interest rates and QE unchanged, there are several signs that point that the economy is improving. Since the MPC’s previous meeting, the near-term economic activity had been positive. The issue now is whether companies and households will increase their spending once the lockdown ends or whether they’ll be cautious. Minutes of the meeting said that Rishi Sunak’s decision to extend the furlough until the end of September has also helped to change the outlook for the unemployment rate.

Indeed, Hugh Gimber, global market strategist at J.P. Morgan Asset Management, highlighted that the economic outlook has improved as “the Monetary Policy Committee is feeling a little more comfortable about the prospects for the economy than at its last meeting six weeks ago. The latest budget confirmed that government lifelines for the labour market will continue, the vaccine rollout is progressing at pace, and a gargantuan stimulus package across the Atlantic should have positive spillover effects across the globe. Against this backdrop, the UK economy is poised for a strong rebound this year.”

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The pound strengthened against the euro, due to positive market sentiment as a result of the intense and ongoing vaccination rollout programme. Goldman Sachs has speculated that the pound could even rise further against the euro.

Rishi Sunak’s Budget announcement boosts sentiment

Following the budget announcement, the Wall Street investment bank told its clients to trade in Sterling as the UK economy is expected to grow in the coming months.  UK Chancellor Rishi Sunak’s budget announcement last Wednesday revealed spending and taxation plans that were better than expected. Sunak announced that an additional £65 billion will be provided for spending, grants and tax breaks with the total additional spending and benefits reaching £352 billion. "The UK economy is well-positioned for the coming recovery," Goldman Sachs’ Zach Pandl said. "The support program laid out by the government surprised consensus expectations to the upside, and included a number of economic incentives aimed at medium-term investment." Most economists believe that supporting the economy generously during the covid crisis will help the economy grow stronger faster and avoid any long-term negative effects.  

Vaccination programme also offers support to pound

Goldman Sachs’ economist Pandl also noted that the UK’s vaccination programme has helped the economy. He said: "Solid household and business balance sheets should soon translate into robust growth, as the UK’s strategy of prioritising getting more people vaccinated with a single dose appears to be paying dividends. We are therefore keeping open the short EUR/GBP component of our long GBP/CHF cross trade.”

Britain has outperformed on its vaccination programme, especially when compared to other European countries, with more than 21 million people having received the first dose of a Covid-19 vaccine.

UK business confidence hits 12-month high

The UK’s fast vaccination programme has also had a positive effect on businesses’ confidence. According to the latest Business Trends report from accountancy and business advisory firm BDO LLP, service sector confidence jumped in February to its highest level since the pandemic began.

BDO’s Services Optimism Index rose to 94.13 in February from 86.60 in January, back towards the long-term average of 100. This is the highest reading in 12 months for the survey, which covers a a wide range of industries from retail and hospitality to professional services.

Also, according to polling firm YouGov, British consumer confidence has risen to its highest level since the coronavirus pandemic started, according to polling firm YouGov. YouGov reported that  consumer confidence rose to 105.4, driven by expectations for house prices, business activity, and household finances over 2022.

The governor of the Bank of England, Andrew Bailey, has also expressed optimism about the economy but also cautioned for unrealistic expectations, as life will not return to pre-Covid levels. He noted that there is a “growing sense” of economic optimism building. He said that Covid has hurt demand and supply which some of the structural changes in the last year will not really change.

Bailey said: “The best we can say is that how the output gap develops in the recovery from Covid will depend on the net effect of the two [demand and supply], both of which will need to move by more than in normal recoveries. There is another element to this part of the story which is hard to assess at present, namely to what extent the more structural changes we have seen during the Covid crisis will persist, and what effect they will have on the recovery? In general, however, economists remain optimistic and the pounds recent surge owes a lot to the government’s successful vaccination programme.

 

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Budget 2021: Pound to Remain Sensitive

Rishi Sunak’s budget has unnerved the pound as investors have been waiting to hear the details. A bullish scenario for the UK currency will be the announcement of more financial support to help recovery, while any attempt to balance the book that will affect growth will hurt the pound.

Main Points: What did Rishi Sunak say?

The chancellor said that he would do “whatever it takes” to help the economy recover from the pandemic as the damage has been great. It is estimated that more than 700,000 people lost their jobs, the economy shrank by 10% and borrowing has been at its highest. Sunak noted: “It’s going to take this country, and the whole world, a long time to recover from this extraordinary situation.”

He has underlined his own and the government’s desire to be clear and transparent about fixing the public finances, and about what plans they have in the future.

Growth

Expectations are for a quick recovery by the middle of next year. However, the economy will still be 3% smaller even in 5 years from now. GDP will grow by 4% this year, and by 7.3% next year. The coronavirus has profoundly affected the economy and Sunak’s comments suggest that tax rises should be expected in the near future.

Furlough

The chancellor said that unemployment will reach 6.5%, which will be much less than originally forecast, with 1.8 million fewer people expected to lose their jobs. The furlough scheme will continue until the end of September. Employees will receive 80% of their wages until the end of the scheme but businesses will have to contribute 10% in July and 20% in August and September. The self-employment income support scheme will also be extended and the £20-a-week uplift in universal credit will be extended for six months.

Grants for Businesses

Sunak announced a £5bn restart grant for businesses and noted that the total direct cash support to businesses has reached £25bn. The Treasury is also starting a new loan scheme with loans ranging between £25,000 and £10m.

Spending

£352bn will be the Covid support package this year and the next and Sunak underlined the amount that was spent to help the economy recover.

Borrowing

Sunak said the budget deficit will be £355bn this year and will continue at high levels with the underlying debt rising indefinitely. He said that due to his actions, borrowing will fall to 4.5% of GDP in 2022-23, then to 3.5% in 2023-24, and 2.9 and 2.8% in the following two years. He added: “It’s going to be the work of many governments over many decades to pay it back, just as it would be irresponsible to withdraw support too soon, it would also be irresponsible to allow our future borrowing and debt to rise unchecked.”

Corporation tax

In April 2023, the rate of corporation tax will go up to 25%. But Sunak explained that this will affect businesses that are making profits of more than £250,000 and will be taxed at the full 25% rate. Companies with profits of less than £50,000 will remain at 19%.

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