The pound is up against the euro more than 1% this month. The BoE is expected to proceed to a second 25-bps interest rate hike on Thursday. For those exchanging the pound against the euro, it will be interesting to see whether the British currency will rise further if the divergence between Bank of England (BoE) and European Central Bank (ECB) monetary policies continues this week too. Sterling is near its highest against the euro, since February 2020, ahead of this Thursday’s BoE and ECB policy decisions. The pound is however set to end the month lower against the dollar, which has strengthened from Fed rate hike bets.

Brexit and Prime Minister’s future

For the British currency, other factors remain into play. The Brexit Freedom Bill passage and UK politics could provide some volatility. In terms of politics, there is optimism in the UK after Liz Truss commented that the Prime Minister’s future is assured. Although Sue Gray’s report is yet to be announced, as it has been delayed due to an ongoing police investigation, Foreign Secretary Liz Truss stated that “The future of the PM is assured.” In a BBC interview, Truss also said: “He’s doing an excellent job on the things that matter -- recovering the economy from Covid, getting Brexit done, getting this country going again.”

While the devolved governments in Wales, Scotland and Northern Ireland have criticised the Brexit Freedom Bill, the Prime Minister has praised it ahead of its official passage. According to Bloomberg: “Legislation building on Britain’s exit from the EU would make it easier to amend or remove statutes that remain on U.K. books, a measure that will help the government strip away regulations costing businesses 1 billion pounds ($1.3 billion), Johnson’s office said in a statement released Monday.”

Any developments relating to Brexit and UK politics will be of interest to those exchanging the British currency against the US dollar. However, markets will now focus on the Bank of England (BOE) and rate hike concerns following positive domestic data.

Bank of England

The Bank of England is expected to raise interest rates on Thursday as concern over inflationary pressures on households is growing. Economists anticipate the central bank to increase its key rate from 0.25% to 0.5%. With rising household costs exacerbated by high energy bills the Bank’s monetary policy committee (MPC) is anticipated to vote unanimously for a rate rise.

Chief UK economist at Goldman Sachs Steffan Ball, said the MPC would probably vote to raise borrowing costs on Thursday, and could raise rates as much as 1.25% by November this year. Ball said: “We now expect the Bank of England to hike in back-to-back meetings through May, in order to demonstrate to markets and businesses that the MPC is serious about the inflation target.”

Thursday’s policy decision is due out at 12:00 and the pound is expected to rise.

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The pound fell against the US dollar following the January Federal Reserve policy announcement, as the Fed warned that US interest rates could rise in March. Further rate rises by the Fed could also be announced and at a quicker pace, the Fed suggested. The pound has weakened against a strengthening US dollar.

Global risk sentiment was also weak due to concerns about a faster policy tightening by the Fed and political tensions between Russia and Ukraine. As a result, equity markets fell, which further pushed the dollar higher against the pound.  

Sterling was also undermined by the current political turmoil over UK Prime Minister Boris Johnson’s alleged lockdown parties in Downing Street. This has added more pressure on the GBP/USD pair, but expectations that the Bank of England will hike interest rates could help limit losses.

So far, the GBP/USD pair remains at the mercy of the US dollar dynamics, considering also that there are no relevant macroeconomic data coming out of the UK.

Fed announcement

Global markets are unnerved today after the US central bank signalled it is ready to raise interest rates. Federal Reserve chair Jerome Powell was hawkish in tone at last night’s press conference and said that the Fed was ready to raise interest rates in March. He also noted that an aggressive cycle of interest rate rises at coming meetings was also possible.

Powell told reporters there was “quite a bit of room to raise interest rates without threatening the labor market.” He warned that inflation was higher than the Fed’s target while supply chain issues pose considerable risks if they continue to persist.

Investors are now expecting a sharp rise in interest rates this year, after Powell suggested that the Fed could tighten policy faster than expected.

The Fed reaffirmed market expectations for a rate hike in March, which pushed US Treasury bond yields higher. The 2-year US bond yield rose and pushed the USD to the highest level since mid-December.

Pound to strengthen

Financial analysts have noted that the uncertainty around Prime Minister Boris Johnson will unlikely not persist. Additionally, with more positive economic data and Covid restrictions easing, the pound should go higher.

Economists at Westpac said: “The easing of covid restrictions and moves away from working from home should lift economic activity. Nov employment and production were stronger than anticipated and inflation data was notably higher. Dec’s Omicron impacted retail sales were surprisingly weak, but recent survey data suggest that demand has remained firm and maintain potential for another BoE hike.”

In relation to PM Johnson’s position, they pointed out that although there is discontent and calls for him to resign, 15% (54 MPs) of Tory MPs still need to express their lack of confidence to trigger a leadership challenge. While there may be challenges to his leadership, this may be positive as it will end uncertainty and support the pound.  

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The pound rose on Wednesday as expectations for additional BoE rate hikes have increased.

The UK political crisis regarding Downing Street parties during the period that the country was under strict Covid-19 restrictions has capped any meaningful gains for the pound.

The pound’s uptick was not driven by any fundamental news and could be attributed to some repositioning of trades by investors as they wait for the Federal Open Market Committee (FOMC) policy decision.  

“Partygate”

On Monday, ITV News reported that another party took place during the first lockdown period in the UK, this time a birthday party for the Prime Minister. According to the news, Boris Johnson’s wife, Carrie Johnson, organised a surprise party for him on the afternoon of the 19th of June 2020. The allegation has added more pressure on the government, especially after the multiple reports of lockdown-breaking parties in Downing Street and on Whitehall. The Prime Minister has been accused for illegally attending some of the gatherings, including a “bring your own booze” party in the Downing-Street Garden in May 2020. Johnson admitted attending that party and apologised, since, as he said, he thought it was a work event.

The Daily Telegraph already reported that two separate staff parties were held in Downing Street on the eve of Prince Philip’s funeral last year, and during a time when Britain was still in strict lockdown.

As a result, and following public anger, the British Prime Minister has been urged to resign. On Tuesday, the Metropolitan police announced that they have opened a criminal investigation into some of the gatherings. As early as Wednesday, the government could expect Senior civil servant Sue Gray to turn in her report and Johnson's office has promised to publish its findings. The Prime Minister will address Parliament about it soon after. Gray’s report is an investigation into the “partygate” scandal and the 16 parties held at Downing Street and in government buildings during lockdown restrictions in 2020.

Federal Reserve

The Fed is scheduled to announce its policy decision on Wednesday (26/01/2022) during the US session and investors will be closely watching for any signs regarding the timing of its policy tightening cycle. The markets have fully priced in a Fed rate hike in March and expect a total of four hikes in 2022. If FOMC Chairman Jerome Powell notes that they could start reducing the balance sheet in the second half of the year this could boost the dollar and weigh on GBP/USD. On the other hand, it is expected that Powell could adopt a cautious tone on policy tightening which could push the US dollar lower. In that case, the pound could rise against the USD.

Bank of England and UK Stocks

In the meantime, expectations that the Bank of England will hike interest rates further at the upcoming meeting has helped support the British pound.

Tuesday’s outperformance by the FTSE 100 demonstrates that there is strong international demand for UK assets. The FTSE 100 has outperformed its major global peers and managed to hold on to most of yesterday’s rebound. If demand for UK stocks continues, then the pound could find further support.

Investors are now expecting another rate hike at the Bank of England in February which continues to provide Sterling support.

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The pound has fallen to three-week lows against the US dollar due to UK political concerns and the deepening risk-off mood. It has started to recover some of its losses and could rise higher if global market sentiment improves.

With geopolitical tensions rising between Russia and Ukraine and NATO sending reinforcements to eastern Europe, markets are worried, while safe-haven US dollar has strengthened as a result.

Ukraine – Russia tensions

Around 8,500 US troops are ready for a possible deployment to Eastern Europe as Russian troops concentrate on Ukraine's border. US Secretary of Defence Lloyd Austin issued the prepare to deploy orders following the direction of President Joe Biden, as the US gets ready for a potential Russian invasion of Ukraine.

The goal of sending military reinforcements to Eastern Europe is not to take part in any combat but to reassure allies and provide deterrence.

NATO allies have also put forces on standby as the Ukraine crisis escalates. Biden held a video call with European leaders on Monday afternoon in response to Russia's aggressive actions in Ukraine.

Following the online meeting with US, France, Germany, Italy, Poland, the United Kingdom and the European Union leaders, NATO Secretary General Jens Stoltenberg said, "We agree that any further aggression by Russia against Ukraine will have severe costs." He added that "NATO will continue to take all necessary measures to protect and defend all Allies, including by reinforcing the eastern part of the Alliance.”

Moscow has denied any plans to invade Ukraine and accused the US and NATO of escalating tensions over their support for Ukraine. The Kremlin on Monday rejected the reports about plans to install a pro-Russian leader in Ukraine as “fake.” Kremlin spokesman Dmitry Peskov said that “Tensions are escalating due to concrete actions taken by the US and NATO.  I mean, the informational hysteria that we are witnessing. It is generously framed by a huge amount of false information, just lies and fakes."

Pound outlook

Further to geopolitical tensions, the pound has also been affected by global market sentiment. Analysts have pointed out that the pound could recover in the short-term if the global stock market retreat comes to an end. Nonetheless, analysts expect 2022 to be a volatile year for investors and this will make it harder for analysts and traders to forecast pound price movements.

Sterling has fallen against the euro and dollar after investors sold stocks and other related risk assets in anticipation of higher US interest rates and tensions on the Ukraine border. The outlook remains volatile as the pound tends to fall against the euro and dollar when stocks are sold. Financial analysts believe that volatility will continue as traders readjust to rising inflation and interest rates.

The Swiss franc, US dollar and Japanese yen have all benefited, while the commodity currencies such as the New Zealand and Australian dollars, the Norwegian krone and emerging market currencies have all posted losses.

The pound could benefit from rising demand for UK assets and when investor capital flows back in the UK.

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Sterling strengthened following higher than expected inflation numbers. UK inflation jumped to a near-30-year high of 5.4% and economists have noted that inflation will continue to rise.

Inflation is anticipated to exceed 6% in April and come closer to 7% as supply chain issues come to feed through into prices in the shops and domestic energy bills rise up to 50%. The data which was released by the Office for National Statistics will also affect the Bank of England’s decisions, as the Bank is required to keep inflation close to the government’s 2% inflation target and has continually underestimated the recent price pressures. Traders and investors will closely watch the Bank’s meeting in early February, as expectations for an increase in borrowing costs from 0.25% to 0.5% have now increased.

Inflation

UK CPI inflation for December came at 5.4% year-on-year according to the ONS, beating expectations of a 5.2% reading and surpassing November's number of 5.1%. Core CPI inflation was at 4.2%, higher than the market’s expectation for 3.9%. CPI is now above the Bank of England’s target and the highest since the UK first adopted an inflation target in October 1992. According to the ONS, December's strong inflation numbers were boosted by higher prices in transport, food and non-alcoholic beverages, furniture and household goods, and housing and household services.

Bank of England and interest rate hike

The Bank of England raised rates in December as inflation in the UK rose above the 2.0% target and now markets anticipate another rate rise in February. Markets expect the Bank Rate to reach 1.25% by the end of 2022.

Some analysts believe the pound has further potential to rise following strong employment levels and higher inflation, while others believe that it has reached its highest level.

Inflation to rise further

Economists expect inflation to rise more and to peak in the months ahead, as the energy price cap is raised. With prices on the rise and real wages already falling, households will struggle with the cost of living.

Chancellor Rishi Sunak commenting on today’s data said: "I understand the pressures people are facing with the cost of living, and we will continue to listen to people's concerns."

The government has been urged to find solutions to protect those consumers who will struggle the most as prices continue to rise. The CBI has also called the government to provide support to struggling firms, especially energy-intensive businesses. In the coming months, the release of more data may reflect higher costs being passed from firms over to consumers as they try to maintain their company margins. Higher energy prices and tax rises will contribute to the looming cost of living squeeze. The TUC, which includes 48 member unions, has also called the government to come up with a plan to deal with the UK’s cost of living crisis. TUC general Secretary Frances O’Grady said that families are facing higher inflation pressures and slowing wage growth and need more help from the government.

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The pound has remained supported despite US dollar strength, helped by positive jobs data released this Tuesday morning. The good UK jobs data is also supporting expectations of further interest rate hikes by the Bank of England (BoE).

Chancellor of the Exchequer, Rishi Sunak, has welcomed today’s data and said that the “figures are proof that the jobs market is thriving, with employee numbers rising to record levels, and redundancy notifications at their lowest levels since 2006 in December.”

Unemployment rate drops

The jobless rate fell to 4.1% during the quarter of September and November, according to the Office for National Statistics. After the end of the furlough scheme, the labour market has proven to be resilient and has continued to grow stronger in November. While wage growth slowed down, it remained above 4.2%.

The ONS estimates that employers added 184,000 more staff in December, pushing payrolls higher, to 409,000, which represents 1.4%, above pre-pandemic levels.

Vacancies increased too, with 1,247,000 vacancies in October-December. Most industries have shown a high number of vacancies, but the ONS warned that the rate of growth in vacancies has slowed. There are 462,000 more vacancies than before the pandemic. The redundancy rate has fallen which means that the end of the furlough scheme did not significantly affect the jobs market.

Economic inactivity rate rose by 0.2% to 21.3%. This suggests that an increasing number of people have left the labour market, either because they have retired, started studying or are ill.

Consumer price inflation (CPI) rose to 5.1% in November and is expected to hit 6% by this spring when energy bills increase.

Wages

The ONS reported that wages fell as prices rose in November: “In real terms (adjusted for inflation), total and regular pay have shown minimal growth in September to November 2021, at 0.4% for total pay and 0.0% for regular pay; single-month growth in real average weekly earnings for November 2021 fell on the year for the first time since July 2020, at negative 0.9% for total pay and negative 1.0% for regular pay.” The ONS showed that public sector was hit by the pay squeeze: “Average total pay growth for the private sector was 4.5% in September to November 2021, while for the public sector, it was 2.6%; all sectors saw growth, with the finance and business services sector seeing the largest growth rate at 6.8%.”

Cost of living

The UK’s cost of living is going to get worse according to Stephen Evans, chief executive of Learning and Work Institute. He warned that 2022 “will be dominated by the cost of living crunch and labour shortages.” He stressed that today’s data has shown that prices rose faster than wages, and with inflation pushing higher and further tax rises households will struggle. He clarified that the total number of working people was still below pre-pandemic levels, while the growing number of those being sick meant that there are now one million less people working than before the pandemic.

The chancellor, Rishi Sunak, highlighted the positive figures and said the government’s plan for jobs was creating opportunities for all including traineeships for young people and sector-based work academies for those changing careers.

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Pound rose on Monday, with investors focusing on the highlight of the week, the release of inflation data on Wednesday. Sterling had strengthened last week, on Friday, following positive UK GDP data, which came at 0.9%, beating expectations of a 0.4% reading. This has put the UK economy above pre-pandemic levels and helped lift the pound.

In the week ahead, traders will focus on UK inflation and the release of retail sales. If UK inflation rises by more than expected then the pound could go higher, as this may increase the possibility of an interest rate hike by the Bank of England.  

For the UK retail sales, investors expect sales to fall by 0.6% in December, but any surprises could create volatility for the British currency.

UK Inflation

Wednesday’s inflation figures will be the main driver for the pound and the most important release for the UK, for this week. They will come ahead of the Treasury Select Committee meeting where Bank of England (BoE) Governor Andrew Bailey, Deputy Governor Jon Cunliffe, and external members at Financial Policy Committee, Dame Colette Bowe and Elisabeth Stheeman will provide oral evidence in relation to the December Financial Stability Report. The BoE’s Financial Stability Report sets out the Financial Policy Committee's view on the UK financial system’s stability and what actions will be taken to remove any potential risks.

 After rising to 5.1% in November, CPI inflation is expected to rise further in April as utility prices increase, according to economists at Capital Economics. When utility prices rise on 1st April, around 50%, then this will add 2.1ppts to overall inflation pushing it up to 6.9%.

Economists expect that the annual rate of inflation rose from 5.1% to 5.2% in December. This will create sensitivity to the pound, especially if this affects market expectations for the timing of another interest rate rise from the BoE.

Could the pound rise further this week?

The pound could benefit if Wednesday’s inflation data is better than expected and the market strengthens its belief that February is more likely the right time for the BoE to raise the interest rate further. Markets expect a series of interest rates in 2022, an expectation that has already helped boost the pound, and could lend further support if inflation data beats expectations. However, any change in rhetoric by the European Central Bank (ECB) that could be seen as supportive to the euro will act as a headwind to Sterling. The ECB has insisted that it has no intention of raising interest rates in the Eurozone this year but with inflation rising in December, it could begin to accept the need to act in the months ahead.

But with limited news coming out of the Eurozone, analysts have noted that the pound to euro rate will be mainly affected by Wednesday’s inflation figures and any relevant commentary from BoE Governor Bailey and his colleagues when they offer their latest testimony about the latest financial stability report.

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The pound has risen very slightly on Friday (14/01/2022), despite better-than-expected UK data.

UK GDP for November

GDP rose 0.9% m/m in November, above the forecast of 0.4%, while Manufacturing Production jumped 1.1% m/m, surpassing the expected 0.2%. Both figures were higher than the October releases and demonstrate that the UK economy continues its recovery. GDP for Q4 is expected to reach or go beyond the pre-pandemic level (Q4 2019), eliminating any possibility for disappointment for the December GDP report.

The Gross Domestic Product released by the National Statistics measures the total value of all goods and services produced by the UK. It is considered as a comprehensive measure of UK economic activity and as such, if it rises, this has a positive effect on the GBP, while, if it falls, then this is seen as negative for the British currency.

Despite the good news, business groups have warned that the economy remained weak, as inflation has continued to rise, and the Bank of England could further raise interest rates. Suren Thiru, the head of economics at the British Chambers of Commerce, said: “Stronger growth in November is likely to be followed by a modest fall in output in December and January, as consumer caution to socialise and spend, and mounting staff absences sparked by Omicron and plan B limit activity. While the UK economy should rebound once plan B measures are lifted, surging inflation and persistent supply chain disruption may mean that the UK’s economic growth prospects remain under pressure for much of 2022.”

While analysts anticipate stronger growth in 2022, consumer spending will be limited due to the rising cost of living. Wages are expected to go up around 3.5% in 2022, as prices rise.

The chancellor, Rishi Sunak, congratulated the “grit and determination of the British people” and noted how “amazing” it was to see the economy back to pre-pandemic levels in November. He said: “The government is continuing to support the economy, including through grants, loans and tax reliefs for businesses, and our plan for jobs is ensuring people up and down the country have fantastic opportunities. We all have a vital part to play to protect lives and jobs, and I urge everyone to do theirs by getting boosted as soon as you can.”

Johnson under criticism

Prime Minister Boris Johnson is under criticism after revelations that his staff held parties during the Covid lockdown. Boris Johnson is already facing calls to resign from the opposition and some senior Tories after he admitted attending a drinks’ gathering in May 2020. According to the latest news, Downing Street staff held two parties during Covid restrictions with both taking place the night before Prince Philip's funeral. The Telegraph reported that the events took place on 16 April 2021 and continued past midnight. Prime Minister Boris Johnson was not at either party, but the events raise questions about the culture at No 10, Labour's deputy leader Rayner said.

Johnson has urged MPs to wait for the outcome of an investigation into lockdown gatherings by senior civil servant Sue Gray, which is expected next week.

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UK Prime Minister Boris Johnson has come under scrutiny after he admitted attending a drinks party in lockdown. The British Pound has proven resilient and did not fall following calls to resign.

The pound rose to its highest level against the US dollar and is close to two-year highs against the euro despite signs that members of the Conservative party are dissatisfied with the Prime Minister. This raises the chances of Boris Johnson being replaced as a leader in 2022.

Traditionally, the pound has come under pressure during periods of political instability, uncertainty or anxiety, such as the Brexit referendum, but the current developments have not impacted the pound. Sterling ignored political risks and reached two-month highs against the US dollar, proving that the markets are not convinced that Johnson will resign.

Controversy over the Downing Street party

Johnson has denied breaking any rules regarding the May 2020 gathering in the Downing Street garden. The Northern Ireland secretary, Brandon Lewis, has noted that the prime minister was “very, very sincere” when he apologised for attending what he thought was a “work event” and what his principal private secretary had called “socially distanced drinks.” Lewis told Sky news that the PM doesn’t believe that he has done anything outside the rules. “If you look at what the investigation finds, people will be able to take their own view of that at the time,” he added.

Johnson’s apology has not soothed the concerns of many Conservatives, with some of them including the Scottish Tory leader, Douglas Ross, and the senior backbencher William Wragg calling for him to resign. A number of other cabinet ministers were slow to express their support for Johnson.

Some MPs suggested Johnson was unremorseful when talking to colleagues after his apology at the House of Commons. Talking to BBC Radio 4’s Today programme, Lewis clarified that the PM regretted doing what he did and that he did “recognise the anger and upset and frustration that people feel at what they perceive happened at No 10.”

Sterling remains one of the best performing G10 currencies*

Despite the political controversy surrounding PM Johnson, the pound remains at the top of G10 currencies for the month.  Analysts have also underlined that the political risks are not threatening in any way as a UK election is not scheduled until 2024.

While this might be the most difficult period of Boris Johnson’s tenure, markets are not concerned and not willing to price in any political risks. Additionally, markets do not appear to be threatened by a new PM in the form of Rishi Sunak or Liz Truss who are the favourites among Conservative members. Both The Times and The Telegraph have published headlines pointing that Rishi Sunak is believed to have what it takes to be the next PM. The situation is also different than the election period of 2019, as there are no Brexit risks. The next PM is not expected to call a snap election and the government’s majority will remain intact.

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* G10 currencies are the most important currencies traded in the currency market and the most widely used within the financial markets. These include the US dollar, euro, British pound, Japanese yen, Australian dollar, New Zealand dollar, Canadian dollar Swedish krona, Norwegian krone, and the Swiss franc.

The pound has slightly dropped from its over two-month high which it reached this Wednesday, but the outlook remains positive with traders expecting additional gains. Researchers at Barclays also anticipate the pound to continue outperforming its major peers over the coming months.

The pound’s retreat today was not driven by any specific economic factor and could be attributed to traders readjusting their trades ahead of the all-important US consumer inflation figures.

Pound’s positive performance could continue researchers say

Markets generally believe that the pound’s strong performance in the first week of the new year was largely driven by expectations for a February interest rate hike and this could continue in the coming weeks and months.

The market now expects a ~75% chance of a second rate hike at the BoE’s February  policy meeting. This has also been further boosted by expectations that the US Federal Reserve will proceed to a faster and earlier interest rate hike cycle in 2022.

With inflation rising in both the UK and the US, markets expect higher interest rates in the US and the UK, which will support the British currency.

UK retail sales

The latest annual Retail Sales Monitor report from the British Retail Consortium (BRC) showed that sales grew, but consumer spending slowed the final weeks of 2021. The British Retail Consortium said that UK retail sales grew by 2.1% in December with growth coming in at 9.9% year on year. Government restrictions slowed spending, but in general the Omicron variant did not have a massive impact as retail sales held up through December. However, January is expected to be a more difficult month for the high street with footfall at UK outlets seen lower in the first week of January.

Businesses in the retail sector have warned that the spread of Omicron and the increasing costs of living could have a significant impact on sales this year.

Bank of England interest rate hikes

While a February rate hike would be the second interest rate rise in just two months, the total number of hikes to be delivered in 2022 is yet unknown and will be a crucial factor in the pound’s performance.

The Bank of England's unexpected December rate hike has led the market to believe that there will be more near-term rate hikes. As it becomes clearer how the Bank is expected to act and how many rate hikes will be delivered over the coming months, the pound will gain further support.

With the Omicron variant slowly subsiding and markets regaining optimism the British currency will also gain traction. As BBC reported on Wednesday, Covid cases in the UK are decreasing according to the daily figures released by the government, with the number of cases confirmed over the past seven days having fallen 13% compared to the previous week.

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