The outlook for Sterling will remain at risk as market analysts are cautious for the UK currency, especially with the new week having started with further pound declines.

Bank of England policy meeting

While the pound has enjoyed gains in the beginning of the new year and until recently, analysts are slowly becoming more cautious following last week’s sharp decline with traders less confident in the currency. Therefore, traders will focus on this week’s Bank of England policy meeting on Thursday for some direction for Sterling. If the Bank of England's Monetary Policy Committee delivers a more hawkish than expected message then the pound could regain some of its recent losses against the US dollar, analysts believe. On Thursday, the Bank of England will provide their latest assessment on the UK economy but is not expected to take any action and it will leave interest rates unchanged. It will be in August’s policy report that any possible major changes in the Bank’s direction will be announced, and the market will focus on such expectations and whether economic recovery will drive the Bank to change interest rates next year. If the Bank reveals any signs that it is going to move towards this direction, then the pound might be lifted by the end of the week.

Potential dangers for the pound

Some analysts believe that much of the positive news is already priced in and that the pound will be vulnerable to downside moves if economic data disappoints. It has also been noted that we should be more optimistic as the pound has responded rather well to economic data, but that currency risks are indeed real and could potentially hurt the pound. For example, there are currency risks related to the futures market as there are traders who are holding long positions—meaning they have purchased Sterling and are waiting for the currency’s price to go up—and when those positions are undone and the pound is sold, they will expose the pound to a fall.

There are also risks regarding the pound’s performance and the loss of momentum. The Sterling 2021 rally has now stopped, and this is a possible reason for concern.

Another possible reason for concern is the rising tensions between the UK and EU and a potential trade war about the Northern Ireland protocol. The EU has threatened the UK with tariffs on UK exports if Britain fails to implement the Northern Ireland protocol. Analysts remain cautious as discussions continue and further potential challenges arise. It was announced last week that the UK government requested from the EU the suspension of some elements regarding the Northern Ireland protocol until October, while they strive to reach an agreement on transporting chilled meat products from Great Britain to Northern Ireland. Any news regarding tensions between the UK and EU on the Northern Ireland protocol could trigger Sterling volatility.

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The pound rose against the euro, the US dollar and other major currencies after the release of better-than-expected UK inflation numbers. UK inflation rose to 2.1% for May according to the ONS, which is now above the Bank of England's 2.0% target.

High inflation means that the Bank of England could signal that it will tighten monetary policy soon, which will offer further support to Sterling.

Core UK inflation, which excludes the price of food, alcohol, tobacco and other volatile items, also rose to 2.0% in the 12 months to May, much higher than expected. This suggests that businesses are raising their prices following the lockdown due to rising costs. Most of the increases in music downloads inflation (from -5.1% to +3.4%) games, and hobbies inflation (from -0.6% to +2.7%), will be reversed in June, according to analysts.

UK Inflation

With the UK economy slowly emerging from the Covid-19 lockdowns, the cost of fuel, clothing and eating out increased pushing inflation across the UK higher and over the Bank of England’s target for the first time in almost two years. The UK consumer price index jumped to 2.1% in May, which is the highest CPI reading since July 2019.

The Office for National Statistics said that transport was one of the biggest sectors who boosted inflation, as petrol prices rose significantly. Prices for clothing, games and recording media rose, while meals and drinks consumed out also helped to increase the cost of living. Food and non-alcoholic beverages’ prices fell this year, after rising a year ago.

The rise of core inflation to 2.0% in the 12 months to May has created some concerns that inflation could rise over the Bank of England’s 2% target for longer than expected. BoE’s chief economist Andy Haldane stressed that Britain was at a dangerous moment, with “some pretty punchy pressures on prices” and the risk that prices could begin “a game of leapfrog”, and possibly lead to a wage-price spiral.

Inflationary pressures building up

There are signs that inflationary pressures are building up in the economy, with UK producer prices rising as manufacturers increased prices by 4.6% year-on-year in May 2020, up from 4% in April. These prices could eventually be passed on to consumers.

Pricier metals and crude oil costs helped to push input costs higher, with copper hitting a record high in May, and oil reaching pre-pandemic highs. The ONS said: “Transport equipment, and metals and non-metallic minerals provided the largest upward contributions to the annual rates of output and input inflation respectively.”

As Yael Selfin, chief economist at KPMG UK said these pressures will ease next year, which means that the Bank of England will probably resist raising interest rates soon. She noted: “Short-term inflationary pressures brought about by a perfect storm of rising oil prices, supply chain misalignments as the global economy reopens and border frictions with the EU, saw UK inflation rise to 2.1% in May, above the Bank of England’s target level of 2%. Changes to VAT will push inflation further this year, although we expect it to average 1.9% this year and 2.2% in 2022. There is a greater level of uncertainty about prices at present, with a possibility that inflation will turn out to be higher if staff shortages persist, triggering stronger wage rises, while cost increases continue to be passed on to consumers. However, with price pressures expected to ease next year and inflation to stabilise around 2%, it is likely that the Bank of England will hold fire and not raise interest rates before 2023.”

For those watching currency markets, the inflation numbers merely confirm that the UK economy is slowly improving, and this should be positive news for the pound as it will remain in demand.

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The pound’s performance in the week ahead will be determined by yesterday's news that Covid restrictions will not be relaxed further until 19th of July. On Tuesday, Wednesday and Friday, investors will focus on the releases of a series of market data, including employment data, inflation figures and UK retails sales numbers, respectively. With investors being interested to see how well the UK economy is recovering, and how the Bank of England will eventually respond by raising interest rates, any sign of strong data will be pound positive.

Covid restrictions

On Monday, markets reacted to the news that the UK government will not fully relax Covid restrictions on 21st June as planned due to the rise of Covid-19 infections over the past week. British Prime Minister Boris Johnson may also announce further government support for businesses, as junior health minister Edward Argar said on Monday.

Foreign exchange markets had already priced in a possible delay, so the news has not provided any immediate volatility. 

However, if the Indian variant of the coronavirus pushes infections and hospitalisations up and the vaccines do not prevent a rise in cases . hospitalisations and deaths, then the pound may be vulnerable to volatility down the line. Foreign Secretary Dominic Raab had said on Sunday that the government’s decision on ending Covid restrictions on 21st of June would depend on whether there was no link whatsoever between infections and hospital admissions - so the change suggests that this is the case.

Economic Data

The coming week will also see a number of important economic data releases, which if they come out strong, then this could prompt the BoE's Monetary Policy Committee to start thinking of terminating its quantitative easing programme before raising interest rates in 2022. This scenario will support the pound.

  • Employment data

On Tuesday, with the release of employment data, investors will be looking to see whether 50K jobs in the three months to April have been added to the economy. The unemployment rate is forecast to come in at 4.7%, down from 4.8% previously. If numbers are better, then the pound will find further support, while any move lower could impact on the pound in the near-term.

  • Inflation numbers

On Wednesday, May inflation numbers are expected to show an increase of 1.8% year-on-year, up from 1.5% previously.  This is almost the mid-point of the Bank’s 1%-3% target range. This will be positive for the pound.

UK retail sales

On Friday, UK retail sales figures could be up, with a reading of 36.8% growth year-on-year in May, which could boost consumer confidence.

The data predictions are generally optimistic and any digression from the numbers could hurt the pound and disappoint the markets.

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Brexit is back in the picture, as there are talks of a potential trade war between the UK and EU over the coming days after both sides failed to reach agreement on the Northern Ireland protocol. The EU has threatened to impose sanctions on UK exports to Northern Ireland if it fails to implement the terms of the Northern Ireland protocol next month. If things escalate, the pound will also be affected, as it usually falls when concerns around Brexit rise.

EU press conference

On Wednesday, UK and EU officials met in an attempt to resolve any disputes over trade rules for Northern Ireland. In the EU press conference following talks with Lord Frost on Northern Ireland protocol, Maroš Šefčovič, the vice-president of the European Commission who serves as the EU’s lead on post-Brexit negotiations with the UK, said that fundamental gaps remained in the UK’s implementation of the deal. On the Northern Ireland protocol, both sides agreed in 2019 this was the best solution to protect the Good Friday agreement. In December last year some solutions were agreed, including grace periods and exemptions in areas where the UK was not ready to implement the protocol. But he highlighted that “we cannot undo the core of the protocol”, as there are still “numerous and fundamental gaps” in the UK’s implementation of the deal.

He also confirmed that the EU could take retaliatory action. Šefčovič says the EU is a peace project, and, as he said, he did not arrive with a list as he is looking for a solution. But he did confirm that the EU could impose tariffs on some UK goods if the Northern Ireland protocol was not implemented. The protocol is designed to prevent checks at the border with Ireland. So, the EU agreed to let the UK conduct these checks at the GB/NI border. The easiest thing would be for the UK to accept EU SPS standards. Nonetheless, Šefčovič says he has a good and honest relationship with Frost and believes in Frost’s “best intentions”.

How will the pound react?

If the relationship with Brussels breaks this could weigh on Sterling sentiment in the short-term. If the EU does take any retaliatory action, and tensions escalate, then the possibility of the UK losing access to the single market would raise significant risks for the UK economy and hurt the pound.

The Prime Minister’s spokesman said: "The protocol was formed in a spirit of compromise, in challenging circumstances. It was not a finished solution... and we didn't expect the EU to take such a purist approach to it. We are working very hard to resolve these issues consensually. But the Prime Minister has always made clear we will consider all our options in meeting our responsibility to sustain peace and prosperity in Northern Ireland.”

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The British pound has come under pressure as there are concerns that the UK’s exit from the lockdown will be delayed. With Covid-19 cases on the rise, the government might postpone the final unlocking due on 21st of June. As Health Secretary Matt Hancock said, the government is "absolutely open" to delaying its plans to ease the restrictions, with a possible two-week delay until the 5th of July. This means that any possible delays will affect confidence in the UK economic rebound, and, consequently, hurt the pound which has had a solid performance throughout 2021.

Lockdown Easing, Indian variant and pound performance

Covid restrictions easing could be disrupted as scientists believe that the Indian variant (known as the Delta variant and B.1.617.2) could spread almost 50% faster than the previous strain in the UK, known as the Kent variant. While the Indian variant might be the cause for potential delays, many analysts believe that this is not enough reason for investors and traders to become especially concerned about the pound’s outlook, as the backdrop remains positive. As economists at ING Bank said, "a 'June pause' probably won't significantly derail the UK's recovery,” unless market confidence “goes into reverse.”

This will also be influenced by how strong business and consumer confidence will be as they will determine whether there will be the necessary funds and investment to drive economic growth. Economic data has up till now been positive with increased bookings in restaurants and pubs, as activity picks up. Economists believe that economic growth data for the second quarter of 2021 will be stronger than many have anticipated, and this will offer further support to Sterling. The potential for the UK economy to beat expectations could also increase confidence and possibly drive the Bank of England (BoE) to raise interest rates sooner than expected.

For the pound but also for other currencies, positive news that central banks will exit their pandemic support programmes will offer extra support. Already, we have seen that for those central banks which have reduced their quantitative easing programme and signalled that interest rates will rise, have seen their currencies outperform.

In general, the majority of analysts believes that the pound will benefit as the economy improves in the coming weeks and months, driven mostly by consumer savings during the various lockdowns. However, a rising number in Covid cases and further restrictions could dampen sentiment.

Short-lived pound weakness

For many economists and research analysts, a potential delay in the easing of restrictions will be damaging, but for others, such weakness will only be short-lived. It is believed the pound will be sold briefly by traders, but then renewed interest will resume.

While the pandemic will continue to affect the economy and the pound, other factors such as economic performance, vaccines, and rising UK real yields will also have an impact on the pound’s performance.

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Sterling experienced some volatility after reaching a fresh three-year high against the US dollar due to expectations for an economic recovery and positive house price data. Some analysts have attributed the surge in the pound to positive global investor sentiment about the UK economic recovery, while others pinned the pound’s gains on a retreat in the US dollar.

US dollar weakness & BoE interest rates

According to strategists at Toronto-Dominion Bank, “The whole ‘U.K. vaccine’ story is a little tired.” It’s probably less about the U.K. and more about the USD, which has been drifting lower overall.”

Beyond the prospect of unlocking the economy, the pound found support from expectations that the Bank of England will soon signal that it may start to raise interest rates next year. The UK’s economic recovery and the potential of the Bank of England ending asset purchases and hiking are encouraging traders to buy the pound.

Concerns about the new variant

However, Sterling has also been influenced by concerns over a new coronavirus strain which pushed the currency lower. The new Indian variant along with concerns about reopening the economy on 21st of June have dented some of the pound’s recent gains. The new strain appears to be more transmissible than previous ones. While the variant did not appear initially to pose a big threat, growing concerns from the government as to whether the UK will fully reopen the economy or there will be delays, have hurt the pound.

The Indian variant is spreading across the UK and the latest statistics suggest Covid-19 cases are starting to rise sharply. The strain is mostly found in England. The government is waiting for more data before it decides to relax restrictions. Politics will also play a role, especially after the criticism the government has faced regarding its handling of the pandemic. Boris Johnson’s government is under political pressure following testimony to MPs by Prime Minister Boris Johnson's former senior adviser Dominic Cummings. This might drive the government to adopt a more cautious approach to June 21.

Any delay will be seen by traders and markets as negative for the pound in the short-term as it could hurt business and consumer confidence while postponing the ability of the economy to recover fully. The fact that such concerns about the economy have also coincided with increasing public scrutiny of the government’s response to the Covid-19 pandemic, they could potentially drive the pound lower against both the US dollar and the euro.  

For this week then, the main drivers for the pound will be any signs showing that the government intends to fully lift Covid-19 restrictions on 21 June and any data regarding the impact of the Covid-19 “Indian variant”.

 

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The pound has potential to rise further as more positive news is expected, while some risks remain relating to concerns about the pandemic and a rising euro. The latest Lloyds business barometer for the month of May rose to a three-year high, while Gertjan Vlieghe, an outgoing Monetary Policy Committee member at the Bank of England (BoE), said on Thursday that interest rates could rise by the middle of next year. At the same time, with a thin economic calendar the pound could fluctuate unpredictably in what is expected to be a volatile week ahead. also mean that the pound

Rising Renmbibi exchange rates

The Pound-to-Euro exchange rate could be volatile with the potential to rise higher if the recent boost in Renminbi exchange rates leads the Peoples’ Bank of China (PBoC) to buy non-Dollar currencies in a bid to ward off dollar appreciation pressures. China’s exchange rates rose after a decision to allow USD/CNH to fall. The move was the result of concerns regarding rising Dollar-denominated commodity prices and was driven by an attempt to offset the increase through a stronger exchange rate. This eventually resulted in the rise of other Chinese exchange rates that are a macroeconomic hazard for the PBoC, as research analysts have noted. The fall of the USD/CNH supported the Renminbi against all China Foreign Exchange Trade System (CFETS) currencies.

The rise of Renminbi is problematic for the PBoC because it results in cheaper imported goods and could drive the bank to buy other currencies in an attempt to reduce its other exchange rates. In general, a prolonged period of RMB appreciation and USD weakness could become an issue for policymakers and the PBoC could use further administrative tools to control this.

The currency pair could also be further affected by the BoE Governor Andrew Bailey’s speech on Tuesday on the subject of "Building a Finance System Fit for a Clean, Resilient and Just Future."

Euro appreciation could drive pound lower

Analysts have explained that the euro could be the main currency in Europe to benefit from the PBoC’s potential attempt to manage extreme currency appreciation. The pound-to-euro exchange rate has performed well, However, if the euro rises, this will potentially push the pound to euro rate lower. On Wednesday, when the ECB releases a report on the international role of the euro, the common currency could rise, and this could possibly push the pound lower.

Covid-19

At the moment, the markets might be relatively calm in both the US and the UK, and after Friday's volatile trading, but fears of Covid-19 variants may send sterling down, some analysts are saying. FXStreet’s analyst Yohay Elam stated that “People residing in the UK may enjoy the long weekend at home and in several European countries – but not in France nor Germany, where they are required to quarantine. These restrictions serve as a reminder of the B.1.167.2 variant. Sterling is on the back foot due to these fears.”

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If you are a business transferring funds overseas, contacting a currency specialist could save you time and money. Get in touch with Universal Partners FX and their dedicated team to discuss the latest market movements ahead of your currency exchange. If you are paying your employees abroad, get in touch with Universal Partners FX to find out how much you can save in your international money transfers. Universal Partners FX can provide invaluable help on efficient risk management and tailored solutions to your personal or business’ transfer needs.