The pound rose on Wednesday following Boris Johnson’s announcement on Tuesday night that the government won’t be introducing new Covid restrictions before Christmas. Sterling was up against the US dollar and the euro. The prospect of new restrictions to contain Omicron, and the drop in trading at hospitality firms and retailers, had pushed the pound lower over the recent weeks.

No new restrictions before Christmas

Boris Johnson has confirmed that Christmas will go ahead without any restrictions on socialising, but this has sparked criticism that this decision will only lead to stricter measures later. The Prime Minister said that he recognised that families across England required certainty to spend Christmas with their families, but he explained that restrictions could still be imposed after 25 December because of the rapid spread of the Omicron variant.

The Prime Minister’s Christmas decision was different than the ones by the Scottish and Welsh governments. On Tuesday, Scotland said that Hogmanay street parties will be cancelled, while Wales announced £60 fines for employees who refused to work from home.

The number of reported Covid cases across the UK fell on Tuesday raising hopes that the recent surge may be starting to level, as there were 90,629 confirmed cases on Tuesday compared to Friday’s 93,045.

In a short video on Tuesday night, Boris Johnson said the situation with Omicron “remains extremely difficult but I also recognise that people have been waiting to hear whether their Christmas plans are going to be affected. So what I can say tonight is that naturally we can’t rule out any further measures after Christmas – and we’re going to keep a constant eye on the data, and we’ll do whatever it takes to protect public health. But in view of the continuing uncertainty about several things – the severity of Omicron, uncertainty about the hospitalisation rate or the impact of the vaccine rollout or the boosters, we don’t think today that there is enough evidence to justify any tougher measures before Christmas.”

Factors impacting on Sterling

As the Prime Minister noted, the possibility of new restrictions cannot be ruled out and will remain a headwind for the pound. This factor, combined with other reasons has limited the pound’s upside potential. The situation in the UK due to the rising number of Covid-19 cases, the potential of new restrictions next week and Brexit tensions have kept traders from buying the pound and limited any meaningful upside for the GBP/USD pair.

On the Brexit front, the UK Foreign Minister Liz Truss, who is now responsible for the Brexit negotiations, said that the UK’s position on the Northern Ireland Protocol remains unchanged. She added that the UK is prepared to trigger Article 16 if the role of the European Court of Justice as a final mediator in dispute-resolution in Northern Ireland is not reduced. Truss, who has taken over after Lord David Frost’s departure on Saturday, is seen by the EU as a more friendly and engaging counterpart. Frost’s resignation was met with relief by EU officials according to Politico. The former Brexit minister was criticised for its anti-EU, libertarian ideology. The bloc now hopes that Truss will be more determined to finish the talks on the protocol and focus on the relationship with the EU, countering Russia in Eastern Europe and the cyberspace.

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Sterling has started the new week lower as Omicron fears have gripped markets. The threat of new lockdowns has rattled markets across the world with all risk sensitive currencies, such as the pound, falling. With reduced central bank support and the ongoing pandemic, investors want to avoid unnecessary risks ahead of the Christmas period.

Global stock markets were also lower partly due to news that President Joe Biden's Build Back Better package did not pass the Senate. Safe-haven currencies such as the yen, US dollar and the Swiss Franc rose as risk-off sentiment turned investors to less risky assets. As it is commonly noted, the pound was lower against the euro which seems to benefit when global markets are down.

Sterling was however higher against commodity currencies such as the Australian and New Zealand dollars.

Risk aversion in global markets

Lockdown risks are rising in the UK as Health Secretary Sajid Javid has not ruled out stricter measures before Christmas after health advisers suggested that more restrictions were necessary to control the rising number of coronavirus infections. Countries such as The Netherlands will enter a full lockdown until at least the 14th of January, while various European countries are considering more restrictions to fight the spread of the virus. Reports suggest that tighter restrictions are expected to be introduced in Germany too.

The recent decline of the pound was driven by a risk aversion mood in global markets due to Omicron. The pound fell as is one of the risk sensitive currencies that falls when global markets seek to avoid risk and traders put their wagers on safe-haven currencies. For financial markets, especially foreign exchange markets, Omicron’s impact on the economy is considerable, and it could reverberate into the new year. Traders are concerned about Omicron’s effects on global growth at a time when central banks are focused on withdrawing support, including the Federal Reserve which will proceed to withdraw stimulus over the coming months.

Inflationary pressures

The introduction of new restrictions comes at a time where inflationary pressures persist, with the global economy struggling to return to pre-pandemic levels following 2020’s restrictions.

According to analysts, financial support programmes to mitigate against pandemic measures will become more costly, and central banks would want to avoid them.

Global growth risks have increased, as President Joe Biden's Build Back Better stimulus package has failed to pass, after Senator Joe Manchin said he cannot vote for the $1.75 trillion package as it will increase the country’s debt and push inflation higher. Americans are already struggling with high inflation taxes and utility bills.

The removal of accommodative monetary policy by many major central banks will affect risk assets and emerging markets, as many developing market currencies have weakened the last six months.

The pound will strengthen if risk sentiment improves, but, at the moment, due to the ongoing pandemic, uncertainty will continue.

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The Pound has strengthened on Friday and is on track to reach its biggest weekly rise since October following the Bank of England’s announcement on Thursday to raise interest rates. The BoE is the first major central bank to raise interest rates since the start of the pandemic. This week, the Federal Reserve has also signalled its intention to tighten its policy in 2022, while the European Central Bank has taken small steps towards rolling back its pandemic-era stimulus on Thursday. It has started by wrapping up its pandemic bond purchases next March. But the Bank does not appear to be raising interest rates soon.

UK interest rates rise to 0.25%

The Bank of England surprised markets on Thursday by raising interest rates to 0.25%. The pound, gilt yields, and bank stocks rose in response of the positive news.

On Friday (17 December 2021), strong UK retail sales data for November along with higher inflation have increased expectations of a February rate hike too.

Retail Sales

The latest positive data on retail sales and resilient consumer confidence have confirmed that consumer demand remains strong. British retail sales rose by 1.4% in November, following strong trading on Black Friday and in the period leading up to Christmas, according to the Office for National Statistics. Retail sales are 4.7% higher than a year before when many shops were closed due to the lockdown. Spending on clothes rose by 2.9%, while other stores such as computer, toy and jewellery shops had a 2.8% growth. With people returning to actual stores, malls and the high street, online retail sales fell to its lowest since the lockdown in March 2020.

Retail sales rose in October too, with consumer spending remaining strong before the Omicron variant hit the economy. According to Heather Bovill, deputy director of the ONS, “Omicron is now casting a shadow over the economy, of course. The work-from-home guidance introduced last week under plan B measures in England has left city centres depopulated, and hospitality firms warn that trading had plunged.”

Expect more rate hikes BoE's Huw Pill says

With inflation shooting higher, the Bank of England chief economist Huw Pill said that the central bank would need to raise interest rates further. Speaking on Friday, Pill explained that the rate increase from 0.1% to 0.25% on Thursday will not be the last and there will be a lot more rate hikes, if inflation remains at its current level. Pill noted that inflation pressures possibly centred around wage pressures in a shrinking labour market will prove persistent.

The hike before Christmas

Deutsche Bank has called Thursday’s Bank of England rate rise “the hike before Christmas.” Deutsche bank’s UK economist, Sanjay Raja, stated that “prudence around inflation” has forced BoE into action. As she clarified, by acting now, the central bank has maximised its chances of meeting their target in two- or three-years’ time.

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The Bank of England has raised interest rates to 0.25%. With inflation at a 10-year high, the Bank was pressured to lift borrowing costs from their record lows. Sterling has risen the last few days as markets have raised their expectations for a rate hike on Thursday. Following the news of a rate hike, the pound rose against the US dollar, reaching its highest level in over two weeks, after falling to one-year lows earlier this month.

With positive economic data reflecting a robust market, expectations for a rate hike had strengthened and today markets were not disappointed.

Bank raises interest rates for the first time since the pandemic started

The Bank of England has raised interest rates for the first time since the pandemic started and despite concerns over the Omicron variant. The Bank’s monetary policy committee (MPC) voted to raise rates from their historic lows of 0.1% to 0.25%, as inflationary pressures outweighed the risks to the economy from Omicron.

Governor Andrew Bailey, Deputy Governors Ben Broadbent, Jon Cunliffe and Dave Ramsden, Chief Economist Huw Pill, and Michael Saunders, Jonathan Haskel, and Catherine L Mann voted to raise interest rates to 0.25%. The only member who voted against was Silvana Tenreyro who preferred to keep the Bank Rate at 0.1%.

Why an interest rate hike now?

The Bank of England has raised interest rates due to inflationary pressures as prices are rising and the labour market looks strong enough. The Bank now expects the CPI inflation rate to reach 6% in Spring, which is more than its 2% target. According to the Bank’s minutes, 12-month CPI inflation rose from 3.1% in September to 5.1% in November and led to an exchange of letters between the Governor Andrew Bailey and Chancellor of the Exchequer. These are included in today’s minutes. The Bank expects inflation to remain around 5% during the next couple of months and hit 6% in April 2022.  

In regards to unemployment, the BoE has assessed the labour market’s condition and recent data that showed that the unemployment rate has fallen and vacancies rose. In their last meeting, the Bank projected that if the economic data and especially the statistics about the labour market were in line with their projections then it would be necessary to raise rates in order to control inflation.

The latest reports have confirmed that these conditions have been met. The labour market is strong and has continued to strengthen. Although the Omicron variant might affect near-term activity, its impact in the longer term is not clear yet.

Bank of England is the first major central bank to raise interest rates

The BoE is the first central bank to raise interest rates in the pandemic. The rate hike comes two days after the International Monetary Fund said the Bank of England should not delay tightening its policy amidst increasing inflation concerns.

The markets are now pricing in further rate rises for next year, with another rate hike in February.

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Thursday's Bank of England policy meeting is expected to create volatility for the pound due to uncertainty as markets do not expect a rate hike, but the Bank could still deliver a “hawkish” surprise. The IMF has said that the time to hike is now but any justification for a rate hike delay would be attributed to the emergence of the Omicron variant and further government restrictions to control its spread.

Market expectations

The market now expects the Bank rate to remain the same at 0.10%. Any surprises from the Bank or solid guidance to quickly push interest rates higher once the Omicron wave has passed in 2022 could push the pound higher. Bank of America and other analysts expect the Bank to keep rates unchanged and signal an interest rate rise in February.

While analysts believe that under other circumstances the Bank of England (BoE) would have hiked rates, the Bank still needs to wait and see as the current uncertainty brought by the Omicron variant could have serious repercussions on the economy with possibly more restrictions coming in the weeks ahead. According to insiders, the furlough scheme which ended in September could be brought back if new restrictions are put in place because of Omicron.

While a small hike could be possible, the foreign exchange market is now expecting rates to be left unchanged. Fading expectations for a rate hike this December were responsible for the weakness in the pound in recent weeks.

The pound and uncertainty about an interest rate hike

For many analysts, there is still much uncertainty about the Bank’s impending decision. If the market has some lingering expectation for a rate hike, then keeping interest rates the same could weaken the pound.

According to Bank of America, there are a number of factors that could hurt the pound as we move into 2022. A rate hike will clearly support the pound, and there are still analysts who believe this scenario. They believe that by Thursday (16 December), the Bank will have sufficient information for a 15bp hike, such as tight labour market conditions. Data from the ONS has shown that the end of the furlough scheme has not resulted in a spike of unemployment and many people on furlough returned to their jobs. The recent news of low unemployment, robust wage growth and increased number of vacancies provide a clear picture of a strong labour market. But some members of the MPC could highlight that the number of jobs and hours worked is still below pre-pandemic levels.

In their assessment of the UK economy, the IMF said that monetary policy needs to withdraw the financial support that was offered during the pandemic in 2020. They expect the Bank rate to remain unchanged, but they believe there will be a clear direction towards raising interest rates rapidly thereafter.

Analysts have noted that the risks for the pound are limited, if an interest rate rise is not announced on the 16th of December. They will be focussing on comments by policymakers and on the meeting’s minutes regarding the reasons for delaying monetary policy tightening.

The pound could gain support if there are strong signals that the Bank will proceed to a number of rate hikes at a later stage, if the costs of the new variant are seen as limited.

While the timing of the first rate hike has now changed and markets expect this to take place in February 2022, analysts at Barclays remain positive and see the pound to appreciate in 2022, supported by the BoE’s tightening, higher inflation and an increased number of inbound mergers and acquisitions.

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The pound was higher against the euro following the release of the latest UK labour market statistics for the period between October and November. However, it remained lower against the dollar as markets have lowered their expectations for an interest rate hike this week.

The data showed that wage growth was stronger than expected, something that suggests inflation will remain higher for longer than the Bank of England had anticipated.

The data has also shown that the end of the government’s job support scheme did not result in higher unemployment, which will further provide the Bank of England with positive news that the UK economy is strong enough to support higher interest rates in the coming year.

The encouraging labour data comes at a time where the UK and the rest of the world is facing widespread concerns about the rise in Covid infections and the spread of the Omicron variant, which might affect the Bank’s decision to raise interest rates any time soon. Markets are now expecting that the Bank’s Monetary Policy meeting on the 16th of December will result in interest rates remaining the same. As Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics, pointed out, today’s report “would have been strong enough to convince the MPC to raise Bank Rate at this week’s meeting, if Omicron had not emerged.” However, despite the emergence of Omicron, the economic outlook is positive for the economy and the pound.

Labour market

Unemployment has fallen again as businesses employed more staff after the end of the furlough scheme in September. The unemployment total fell by 127,000 in the August-October period and pushed the UK jobless rate down to 4.2%. The data shows that the market was strong in autumn, but firms were unable to use the Coronavirus Job Retention Scheme to cover temporarily side-lined staff wages.

The Office for National Statistics also reported that an extra 257,000 people were in payrolled employment in November than the previous month. The number of people working rose by 149,000 and reached to 32.5 million.

Vacancies hit a new record high of 1.219 million in September to November 2021. However, vacancy growth has slowed.

Economists are warning that jobs growth may now be coming to a halt due to the Omicron variant. According to global job site Indeed, “job posting growth may be stalling. As of last Friday, 10th December, postings on Indeed were still 47.3% higher than before the pandemic - but that’s a decline of 0.3% compared to the previous week, on a seasonally adjusted basis. As the Omicron variant takes hold and MPs vote on a new set of Covid restrictions, many sectors that have been doing particularly well this year - from hospitality to high street retail - will be deeply worried that their progress could be abruptly halted.”

Plan B threatens economic recovery

The rise in payroll employment and falling unemployment is positive news for the UK economy and the pound. However, economists have highlighted that 1.2m vacancies remain unfilled, and firms are struggling to hire staff.

The effects of Brexit and the coronavirus pandemic are slowly impacting on the labour market as there are staff shortages which could eventually affect economic activity. Plan B restrictions could also damage the labour market’s recovery especially those sectors affected more severely, such as the hospitality and retail sectors.

Bank of England and interest rate rise

Economists believe that if the Bank of England avoids raising interest rates on the 16th of December, then it will definitely have to raise rates in February, an expectation that will push the pound higher.

The fact that the end of the furlough scheme has not resulted in a surge in unemployment is good news for the Bank, however there are persistent issues, and many have called the government to step in and provide support.

The director of the Institute for Employment Studies (IES), Tony Wilson has said that “despite record vacancies and the tightest labour market in our lifetimes, the number of people out of work and not looking for work is rising” and there is currently almost “one million fewer people in the jobs market than there would have been on pre-crisis trends.” Additionally, he said that with the “prospect of tighter Covid restrictions in the new year, the government needs to be planning now for more support to help people get back into work as well as to protect those jobs that may be at risk in a Plan C lockdown.”

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The pound has weakened due to the new Covid restrictions, and it could fall further, analysts have said. It failed to retain its momentum as the latest coronavirus headlines have put more pressure on the British currency.

Health Secretary Sajid Javid said that the Omicron variant is spreading at a "phenomenal rate" in England, but no Omicron-related deaths have been confirmed yet.

Covid threat is raised to Level 4

On Sunday, British Prime Minister Boris Johnson warned that the UK faces the Omicron "tidal wave" and he vouched that all eligible adults in England will receive the booster dose by the 31st of December. Downing Street explained that without the protection of a third dose, NHS beds would "quickly fill up and the long term damage to the economy and the NHS efforts to bring down the backlog will be even greater." The UK has now raised the Covid threat to “Level 4”, which is one level below the maximum.

Nicola Sturgeon also said on Sunday that the Scottish government will ensure that all adults have access to a booster dose by the end of the year, while Mark Drakeford said the Welsh government will try to accelerate its vaccination program.

3,137 Omicron cases have been reported in the UK on Sunday, which marks a rise of over a thousand since the previous day.

The pound could find it difficult to regain its footing as investors are evaluating the potential effect of the Omicron variant on the Bank of England's (BoE) policy decisions, which will be announced later this Thursday.

Plan B and Bank of England

The announcement of the government’s “Plan B” restriction measures to fight the spread of the Omicron virus was quickly followed by news that a so-called “Plan C” may soon follow, which will have a huge impact on the UK economy and currency as it adds to the uncertainty and potential delays of an interest rate hike by the Bank of England. 

According to analysts, BoE policymakers have already noted that the UK economy has likely met the requirements for an interest rate rise, but the Omicron variant adds significant uncertainty to the economic outlook and will likely mean that a rate hike will be delayed until February.

It’s possible that this week the BoE will leave the Bank Rate at 0.10% and that will push the pound lower. However, since markets are already expecting the bank to keep interest rates unchanged, the effect on the British currency will be limited.

The decision on whether to raise interest rates next week will very much depend on the current uncertainties about the health and economic impact of the Omicron wave, so the Bank is expected to keep a more cautious attitude and wait for more information before deciding to increase the cost of borrowing.

The pound is also expected to remain vulnerable ahead of the latest European Central Bank (ECB) meeting, which could allow the euro to strengthen further. The ECB is expected to announce an increase of its monthly bond purchases as part of its quantitative easing programme called Asset Purchase Facility (APP). However, the ECB could delay this decision due to the current uncertainties.

While expectations have been lowered, and February is most likely the time that the Bank of England might decide to lift interest rates, any surprise decision to lift the rate this week would provide a considerable boost to the currency.

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The pound found support on Tuesday due to a weaker US dollar and improving market sentiment. Fears about the new Omicron Covid variant began to ease and helped to improve the overall market sentiment.

With no negative Brexit-related news, and rising expectations for a rate hike by the Bank of England in December, the pound will remain supported. Apart from this, limited demand for the US dollar will also provide some impetus to the British currency.

Omicron fears ease

News that the Omicron symptoms are mild have helped ease fears regarding the economic effects from the new variant and boosted investor confidence. Equity markets were buoyed but the US dollar’s status as a safe haven was undermined. Expectations that the Fed will proceed to tighten policy and raise interest rates sooner than later has helped to limit losses for the dollar.

Advanced vaccine booster programme

The UK’s advanced vaccine booster programme has also injected markets with hope as analysts believe that the UK’s programme might mean that harsh restrictions might not be necessary. If the UK succeeds with its booster programme and protects the majority of the population, then this could benefit the pound.

As mentioned earlier, markets and the pound will become more positive once more news is announced about the efficiency of vaccines against the Omicron variant. Pfizer is expected to offer some research findings before the weekend.

More particularly, for the pound, what matters is also the government’s response to the number of cases which is currently rising. Markets will watch closely any news from the Prime Minister and how he will deal with the incoming data about the virus and vaccines. There is still much uncertainty about how strong and dangerous Omicron is and how it may be able to infect people despite vaccine protection.

Since the new variant was first detected, global markets have fallen, and the pound posted losses against the dollar and euro as sentiment deteriorated.

Pound at the mercy of external factors

The pound has been at the mercy of global market sentiment and fears about the Omicron variant. Once things improve and it is clear that the variant is not as dangerous, then the pound will gain more support.

The Bank of England is expected to consider raising interest rates on December 16, but the Bank will also take into account the Omicron variant and its effect on the economy.

Prime Minister Boris Johnson said on Monday that over 20 million people have already got their booster jab. Health professionals are worried that the vaccine could escape the protection from vaccines. Omicron now is spreading more quickly than the Delta variant with more cases in London and the South East.

There is a general view that Omicron won’t be a big problem as its symptoms are mild, but experts remain cautious as they fear another wave of hospitalisations. Until more details are made clear about the transmissibility of the Omicron variant, the severity of disease and the effectiveness of vaccines, markets will grapple with uncertainty.

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The pound has fallen against the euro as the market continued to avoid risk currencies in favour of safe-havens. On the other hand, the pound has gained support against the US dollar and reversed some of its losses from Friday following positive Brexit-related news. The UK has granted new licences for French ships to be able to work in British waters which was seen as a sign of progress and offered a moderate rise to the British pound. Apart from this, the broader market risk sentiment will influence demand for the dollar and set the tone for the pound.

Bank of England

A potential risk to the pound is the possibility of the Bank of England (BoE) postponing an interest rate hike on the 16th of December. BoE Monetary Policy Committee member Michael Saunders noted that the new Covid-19 variant has clouded the economic outlook and created uncertainty. Saunders clarified that it is beneficial to wait for more information before tightening monetary policy.

Omicron

Sterling fell against the single currency due to uncertainty regarding the new variant. The spread of the virus in South Africa suggests that this variant has higher transmissibility and affects immunity more significantly than other variants such as the Delta one. South Africa has reported an increase of 11,125 new Covid cases a day, on Sunday, which are less compared to previous days.

The Omicron variant has been found in more than 16 US states, and more cases are expected to be detected, according to Dr Rochelle Walensky of the US Centres for Disease Control and Prevention. Many of the cases were among fully vaccinated individuals who had mild symptoms, although it was not clear whether these individuals have had the booster. The Delta variant accounts for 99.9% of new Covid cases in the United States, Walensky added.

The emergence of such a variant threatens to disrupt efforts to end the pandemic. The World Health Organisation said that the Omicron variant will possibly spread internationally and poses a very high risk of infection that could have a very negative impact on certain places.

The coronavirus pandemic is not over and the next one could be even worse, the creator of the Oxford/AstraZeneca vaccine noted. Professor Dame Sarah Gilbert warned that while “this pandemic is not done with us”, the next one could be even more lethal.

With considerable uncertainty and lack of more information on how fast Omicron can spread globally, markets will remain volatile.

Pound: week ahead

The week ahead could be significant depending on how the market reacts  to new details about the threat of the virus. October’s UK GDP data due out on Friday morning will also provide a clearer view of the UK’s economic recovery in the final quarter. Friday’s GDP data is expected to show 0.3% pace of growth for October, an expansion driven by the services sector, which is now threatened by the virus.

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