The pound is one of the worst performing currencies of the week and last month following Russia's invasion of Ukraine. While analysts have noted that it won’t weaken further, they have also said that there’s little hope for a rebound in the near-term.

Russia – Ukraine War

On Wednesday morning, the British Ministry of Defence published its latest intelligence report on the situation in Ukraine and said that Russian forces have moved into the centre of Kherson, but logistical issues and strong Ukrainian resistance has limited their gains. Russian artillery and air strikes have also continued to hit built-up areas, in the cities of Kharkiv, Kyiv, Mariupol and Chernihiv. Around 660,000 civilians have been displaced and forced to flee the country.

In Kharkiv, Russian troops engaged in fighting with Ukrainian forces while a Russian missile strike hit a police building and a university in the morning hours. Overnight, in Kherson, in southern Ukraine, Russian forces took control of the railway station and the port.

Ukrainian defence minister Oleksii Reznikov said that Ukraine will receive more Stinger and Javelin missiles from abroad, and more Turkish drones.

The United Nations reported that 136 civilians have been killed in the invasion, but the real number of people could be higher. At least 21 people have been killed and 112 wounded from bombing in Ukraine’s city of Kharkiv, according to the regional governor.

Vladimir Putin to ensure Russia’s financial stability

Following reports from Russia state media, President Vladimir Putin has signed a declaration to prohibit Russians from leaving the country with more than $10,000 in foreign currency, in an attempt to ensure Russia’s financial stability.

The Russia news agency stated that “The export of foreign currency cash and foreign currency instruments over $10,000 calculated based on the official exchange rate set by the Russian Central Bank on the day of export will be banned starting on March 2.”

President Biden’s State of the Union address

On Tuesday evening, US president Joe Biden delivered his first State of the Union address from Capitol Hill. He praised the Ukrainian people’s determination to fight and said that Putin must “pay a price” for his actions in Ukraine. The US plans to ban Russian flights from its airspace, the US president confirmed. The decision follows similar ones by the European Union and Canada.

As the US Department of Transportation and Federal Aviation Administration said, by the end of Wednesday, orders blocking Russian aircraft and airlines from entering and using all US airspace will be fully in effect.

Pound and Bank of England

The pound has fallen mainly because investors now expect less interest rate hikes from the Bank of England over the course of 2022 and 2023, following the invasion of Ukraine.

While up until the 22nd of February, 134 basis points of Bank of England interest rate hikes were priced for 2022 in OIS markets (a measure of investor expectations for future rate hikes), by the end of February these expectations have fallen to 126 basis points, and since March to 111.

Such a change in expectations could weigh on the British currency, as the pound tends to strengthen when rate expectations are high.

If the war in Ukraine continues and markets remain on edge, then investors will lower their expectations for rate hikes further, putting the pound under pressure. If, however, anxieties begin to ease and the situation in Ukraine improves, then rate hike expectations will start to rise again.

 

In worrying times like this, it is important for us to point out that we completely acknowledge the wider implications of international conflict. Our principle duty as a company is to ensure that our clients are aware of all of the factors that affect currency exchange rates, which sadly sometimes includes war. Our thoughts are with everyone who is being affected by this escalating situation, and our currency updates do not intend to diminish, ignore or undermine the true impacts of this conflict.

The pound will remain volatile against both the euro and the US dollar as we enter day 6 of the war in Ukraine. Russian forces have launched rocket attacks that killed “dozens” of civilians, including three children, in Ukraine’s city of Kharkiv and began attacking on the capital Kyiv. According to the head of the region, a military base in Okhtyrka, a city between Kharkiv and Kyiv, has been hit by Russian artillery which killed more than 70 Ukrainian soldiers.

Monday’s high-level talks between Ukraine and Russia ended without a breakthrough but both sides agreed to continue the negotiations with a second round of talks to take place in the next few days.

With geopolitical risks persisting, US dollar safe-haven demand will continue, while sensitive to risk currencies will remain under pressure.

UK market news

On Monday, a survey from the US bank Citi and polling firm YouGov said their measure of expectations for inflation in five to 10 years' time has increased to 4.1% from 3.8% in January. The positive inflation data will help the CME’s BOEWatch tool to push the rate hike odds.

Today we got the release of the UK Manufacturing PMI for February, which rose to a three-month high of 58.0, higher than the expected 57.3. Britain’s manufacturers increased production to a seven-month high in February, due to a surge in domestic demand, fewer shortages in raw materials and an easing of global supply chain issues. According to the latest survey from IHS Markit and CIPS (Chartered Institute of Procurement & Supply) cost increases started to ease.

Duncan Brock, group director at the Chartered Institute of Procurement & Supply said that there were many positives for the UK’s manufacturing sector in February as 64% of manufacturing businesses remained confident. However, the positive news could be clouded by potential higher commodity prices as the war in Ukraine continues and supply issues may return in the coming months.

In other news, the deadlock over the Northern Ireland (NI) border and the EU’s termination of funding to the British science studies, due to Brexit, could also weigh on the pound.

In regards to monetary policy, at 6.30pm (GMT) we have a speech by Bank of England’s Michael Saunders and, at 7pm (GMT), a speech by Bank of England’s Dr Catherine L Mann.  Investors will listen closely to those addresses for clues on the extent to which the war in Ukraine could affect monetary policy.

Pound – Euro exchange rate

Pound Sterling was slower to recover than the euro following Friday’s global market rebound, but this week the pound could be more resilient than the single currency during any potential market volatility.

If the situation in Ukraine does not escalate further and Russian forces are overcome by Ukrainian ones, then this could be the best outcome which will also favour the euro.

According to UK chief economist at Capital Economics Paul Dales, “we don’t think that the Russia/Ukraine conflict will delay or derail the Bank of England’s plans to raise interest rates further. That’s because the Bank will probably be a bit more alert to the resulting risk of higher inflation than weaker economic activity.”

As we move ahead, the week will be dominated by developments in Ukraine which will be the main driver for financial markets.