The pound remains strong and is close to last week’s gains against both the euro and the US dollar following Bank of England Governor Andrew Bailey’s comment that the bank is intent on raising interest rates as inflation risks rise.

Many analysts have noted the benefits of an early rate hike, while others have warned about the impact of an early rate hike on UK growth prospects. According to foreign exchange analysts, the pound has found support from expectations that the Bank of England will be among the first major central banks to raise interest rates since the pandemic started.

Bank of England

Bank of England Governor Andrew Bailey said on Sunday the Bank of England intends to raise interest rates if inflation continues to grow. Speaking to the Group of 30, an international body of financial leaders, Bailey explained that UK inflation will be temporary, but rising energy prices will push it higher and for a longer period of time. Bailey said: "Monetary policy cannot solve supply-side problems - but it will have to act and must do so if we see a risk, particularly to medium-term inflation and to medium-term inflation expectations.” He also clearly stated: "We at the Bank of England have signalled, and this is another such signal, that we will have to act. But of course that action comes in our monetary policy meetings."

Some analysts believe that the shift in monetary policy will outweigh the negative effects of slow economic growth and will slowly push the pound higher.

Rabobank: Risks Ahead

The prospect of the pound rising next year and beyond could be hindered by fears around the medium-term outlook for the UK economy. Rabobank said: “Tensions with French fishermen and disagreements about the Northern Ireland protocol have brought warnings of a trade war between the UK and the EU. Neither had had a significant impact on the pound to date. That said, this is a risk that the differences between the UK and the EU won’t be resolved easily and, on the margin, this news-flow provides an additional disincentive to GBP investors.” They added: “We are not expecting the BoE to raise rates in the coming months and see scope for GBP to edge lower on disappointment.”

Next Interest Rate Rise

Money markets are now expecting a rate rise in November, and as many as three rate hikes in 2022. If the Bank disappoints and does not proceed to a rate rise, the pound will fall. At the same time, other analysts have talked of a Bank of England policy mistake as they believe raising interest rates would slow down growth. A more aggressive BoE tightening will push borrowing costs for households and businesses higher and will impact the UK housing market. Stagflation (no growth and high inflation) fears will add to concerns about the pound.

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Improved market sentiment has helped push the pound higher against the euro and the US dollar. Comments from two of the Bank of England's Monetary Policy Committee (MPC) members Silvana Tenreyro and Catherine Mann, who spoke out against an early rate rise, did not affect the pound.

Pound Rises

The British pound rose despite comments from the Monetary Policy Committee (MPC) member Silvana Tenreyo, who said the current rise in UK inflation is temporary and that it was early to raise interest rates.

In other news, the European Union threatened to retaliate if the UK abandons the Northern Ireland deal. Nevertheless, Sterling rose on improved risk sentiment.

Bank of England

Two of the Bank of England’s monetary policy committee members have said they prefer to wait and see how gas prices and shortages of raw materials will influence inflation before voting for an interest rate hike. Both economists highlighted that economic recovery remained uncertain.

  • Catherine Mann

Catherine Mann, who is a former chief economist at the Organisation for Economic Co-operation and Development and the US bank Citi, said that it was best to wait and see as traders are currently betting on tighter monetary policy in the UK and US. Mann said that market participants were doing the bank’s job because by speculating on what the bank will do have driven the cost of borrowing in financial markets higher, which, as Mann explained, is what a rate rise would do. She noted: “They see that monetary policy normalisation is the direction of travel … and so they are doing their homework and they are starting to price in that direction of travel.”

  • Silvana Tenreyro

Silvana Tenreyro was also against an early rate hike.  Speaking to BusinessLive Wales, she said even a rate rise could be “self-defeating” if inflationary pressures prove to be temporary. Tenreyro said that the current level of inflation was considered against last year’s low prices. Additionally, the surge in the global price of energy and other commodities pushed inflation higher but these are usually temporary. Tenreyro explained: “The prices go up, but they don’t keep going up sustainably, so you have a one-off price effect and in that sense inflation should be transitory. She also said: “By the time interest rates were having a major effect on inflation, the effects of energy prices would already be dropping out of the inflation calculation. If some effects were to prove more persistent, it would be important to balance the risks from a period of above target inflation with the cost of weaker demand.”

Many investors are speculating that the BoE will raise interest rates before the end of the year, becoming the first major central bank to raise rates since the start of the coronavirus pandemic.

 

 

 

Foreign exchange investors are interested to see how central banks will choose to act and when they plan to raise interest rates.

The Pound's rally higher despite dovish comments by Tenreyro, suggest that her views are already known and unsurprising and are not powerful enough to deter the majority of the Bank’s members raising interest rates. Some analysts expect an early rise to boost the pound, while others are arguing that a rate rise might be bad for the pound as it might raise costs at a time that growth is slowing down.

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Brexit might had gone away for a while, replaced by more prescient concerns such as the pandemic, slower economic growth, supply chain issues and higher inflation, but it is making a comeback. Tensions between the EU and UK over the Northern Ireland agreement could put an end to potential gains, analysts gave argued, while inflation worries could also put more pressure on the currency.

A weaker US dollar and falling US Treasury yields have also helped both the euro and pound rise. Despite higher wages in US inflation data and rate hike expectations, the US dollar fell from Wednesday’s almost one-year high.

Bank of England: First to raise interest rates

The pound was higher yesterday following data that showed the economy grew 0.4% in August, 0.8% smaller than February 2020, the Office for National Statistics said. Economists were expecting a monthly gross domestic product growth of 0.5% for August. The biggest impetus for the pound is the expectation that the BoE will be the first central bank to raise interest rates since the start of the pandemic, with some investors expecting a rise to 0.15% by December.

Sterling was at a two-week high on Monday due to weekend headlines that Bank of England governor Andrew Bailey, and MPC policymaker, Michael Saunders, warned of inflationary risks and the need to act, raising interest rates earlier and preventing inflation from becoming permanently embedded.

Analysts believe that the Bank of England's move towards raising interest rates will push demand for the pound higher. However, other analysts have argued that moving too early might risk economic growth, especially at a time when the growth outlook is subdued.

Brexit

The positive news that Brussels plans to reduce checks on goods entering the region has done little to provide fresh impetus to the pound. The new plan, which seeks to resolve a dispute over a key part of the Brexit agreement, would remove about 80% of spot checks, while customs paperwork would also be cut by 50%.

However, UK Brexit Minister Lord David Frost’s demand to rewrite the Protocol to remove the oversight role of the European Court of Justice (ECJ) might create further tensions.  On Wednesday, a UK government spokesman said both sides should start a new round of "rapidly conducted" talks to tackle such issues as governance, since a solution needs to be found that protects the Good Friday Agreement and strengthens the relation between the EU and UK.

Democratic Unionist Party (DUP) MP Ian Paisley told the BBC that Prime Minister Boris Johnson told him "personally that after agreeing to the protocol he would sign up to changing that protocol and indeed tearing it up, that this was just for the semantics".

Talks between the EU and UK on the new proposals might last for several weeks. Any renewed tensions and disagreements could spark more pound volatility.  

 

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The pound is not expected to rise higher from current levels, analysts have said.  Brexit tensions and an early interest rate hike by the Bank of England could eventually push the pound lower. Barclays warned of possible Brexit tensions rattling the foreign exchange market, while HSBC analysts said that the pound is not cheap and that there are significant risks to the UK outlook.

HSBC analysts

HSBC currency analysts believe that the pound should have been higher than current levels, considering market expectations for an earlier rate hike. The fact that the British currency has failed to advance despite these developments, suggests that political risks are returning to the currency.

HSBC analysts do not see scope for further Sterling gains, as the pound faces opposing forces including growth, inflation, rate expectations and external balances. They argue that the pound’s trajectory will become clear once one of these forces dominates the other. The bank said that Sterling could gain in the near-term due to the Bank’s expected rate increases but this would be offset by a deteriorating economy as the Bank’s monetary tightening fades quickly. The high energy costs combined with higher inflation will slow economic growth, the analysts added.

  • Brexit vote and financial crisis

HSBC noted that the pound has been deeply affected by the Brexit referendum in 2016 and earlier by the 2008/9 financial crisis. Both events have influenced the fair value assessments of the pound and they argue that currently the UK currency is closer to fair value and even expensive against other currencies.

  • Inflation

HSBC bank notes that the UK is expected to grow at a slower pace while exhibiting the highest inflation in over a decade, with fears of stagflation hurting the pound. In a survey conducted by Barclaycard, 90% of the shoppers said they were concerned that rising costs of everyday items would affect their household finances.

Barclays

Barclays analysts are also concerned with the pound outlook as they have pointed out that tensions between the EU and UK over the Northern Ireland protocol could negatively impact on the foreign exchange market. Failure to reach an agreement might result in the UK triggering Article 16 of the protocol, triggering retaliation measures by the EU such as tariffs and impacting on the Trade and Cooperation Agreement (TCA). Any such scenarios will hurt the pound.

Britain wants to negotiate a “new protocol” to regulate post-Brexit trade in Northern Ireland, Britain’s Brexit Minister David Frost said in Lisbon on Tuesday. Ahead of the European Commission's formal response to the UK’s plan, Lord David Frost said the EU would be making a “historic misjudgement” if it refused to rewrite the Brexit deal covering trading arrangements for Northern Ireland. Brussels has warned the UK that they are not in a position to indulge themselves in important renegotiations.

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The pound is not in any crisis, Pound Sterling Live argued this morning, citing a range of media and newspapers that continue to claim that the pound is in trouble. There are potential dangers of course, especially from a return of Brexit anxieties, but there are also supportive factors such as the ongoing economic recovery and the prospect of an early Bank of England interest rate rise in late-2021/early-2022. Analysts at Pound Sterling Live also noted that a mixed set of views on the outlook of a currency is a common thing and does not signify a serious concern.

Pound concerns

At the same time, Bloomberg, has warned that the pound is going to fall, and said that investors are betting against the pound as they are worried that Bank of England’s efforts to reduce inflation would hurt consumer sentiment and the growth outlook.

Traders have increased their bets against the pound, as they expect the currency to fall at the fastest rate in more than two years. Canadian Imperial Bank of Commerce, RBC Europe Ltd., and Société Générale SA strategists are also expecting the pound to fall to levels last seen in late 2020. Bloomberg highlighted that sentiment was at its most bearish in seven months, as traders are not optimistic on the pound. 

The UK’s high inflation and low growth are also reasons for concern for Bank of America strategists who said “any strength in the pound is an opportunity to sell.” Analysts are concerned that inflation and the end of the furlough scheme will influence real incomes. Governor of the Bank of England Andrew Bailey warned of a potentially “very damaging” inflation period unless the Bank acts accordingly. By tightening its policy earlier, the Bank could also tighten household spending and increase mortgage payments, undermining the UK’s recovery.

Strategists for RBC have also noted that higher interest rates could push the pound lower, and many are concerned that if the Bank moves too fast, there will be a squeeze in real incomes, which is already evident due to high energy prices and tighter fiscal policy.

Pound not in crisis

While the pound to dollar rate might be weaker, the drop is not demonstrating a “chaotic” fall, Pound Sterling Live analysts have suggested. They have criticised different analysts who have linked supply chain issues to the UK’s performance. While such problems are real, Pound Sterling Live analysts have argued that such issues are not specific to the UK, and they pointed to the US and similar supply chain issues.  In regard to the fuel crisis, they criticised panic-buying and motorists who have run to fuel stations. They have also pointed out that the connection of the pound to emerging market currencies is false, as a lot of the weakness of the pound can be blamed to a stronger US dollar. As they say, many investors have mistakenly taken a very negative stance towards the pound, arguing that there are tougher times ahead and the macro-outlook for the pound is deteriorating.

The dollar’s safe-haven status and its higher demand in times of global economic nervousness has helped elevate it at the expense of the pound.  Pound Sterling Live has also clarified that the mixed range of forecasts offered by major financial institutions is not indicative of a crisis but is natural among other currencies. Risks of course remain, but they argue that the negative pound outlook is overstated.

 

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The pound was up against the euro on Wednesday, strengthened by higher UK bond yields and expectations of an earlier interest rate hike by the Bank of England. Sterling rose to a three-week high against the euro yesterday, as traders returned their attention to the prospect of interest rate hikes in Britain. The pound was down last week, due to rising inflation concerns, but it has now recovered.

Sterling’s recovery is mainly due to the prospect of the BoE raising interest rates sooner than expected, but analysts have commented that the pound should have risen even higher especially because of the important difference between the European and UK central banks. While the BoE has clearly stated its intention for an earlier rate hike, the European Central Bank has no plans to raise rates soon. Economists have warned that caution should be exercised though, as the pound’s gains might not be long-lived. It is still unclear whether the BoE will proceed to raise interest rates while the UK is facing ongoing supply problems.

Inflation

On Tuesday, British Prime Minister Boris Johnson said inflation fears were baseless. The final reading of the IHS Markit/CIPS composite Purchasing Managers’ Index showed that companies increased prices at the fastest pace on record, following shortages of staff, raw materials and transport.

Brexit

The pound has yet to react on Brexit risks after the UK told the European Union on Monday it would  “trigger safeguard measures in their divorce deal if the bloc failed to agree to changes to smooth trade with Northern Ireland.” Speaking at the Conservatives' annual conference in Manchester, Brexit minister David Frost stated that "Without an agreed solution soon, we will need to act, using the Article 16 safeguard mechanism, to address the impact the protocol is having on Northern Ireland." The EU is putting together a package of measures to ease the passage of goods from Britain to Northern Ireland, using flexibilities in the protocol, which will announce next week.

Tighter policy could weaken pound

Goldman Sachs Asset Management has said that tighter policy could weaken Sterling. The firm’s strategist for the global fixed income team said that high inflation and energy prices, and Brexit implications could further complicate the inflation outlook. Fears of higher inflation combined with the ongoing supply-chain crisis and an end to the government’s furlough program have worried investors who believe the BoE may choose to raise interest rates sooner than necessary, risking economic recovery.

Other firms and financial analysts are less concerned as challenges are not seen as dangerous and are merely transitory. They don’t believe that the Bank will be forced into a dangerously fast pace of tightening.

What to watch

A key indicator to watch is the UK's labour market as unemployment is expected to increase in October since the government's job support scheme ended on the 30th of September and furloughed staff might not be able to return to their old jobs. The furlough scheme which started in March 2020, supported 11.6 million jobs across the UK and government figures suggest that around a million people were still on furlough when it ended.

If unemployment is lower than expectations, the consensus is that the Bank could move towards a rate hike as a strong labour market will increase the potential for wage rises which push inflation higher.

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The pound is expected to stabilise and rise further according to analysts as investor sentiment is strengthened and the Bank of England is moving toward tightening its policy next year.

The pound stabilised against the euro but remains to be seen how well it will perform against the dollar as Friday’s jobs report will determine the outcome.

Pound is in recovery mode now

The pound dropped last week after concerned investors sold Sterling against the euro and the US dollar fearing higher inflation following the global energy crisis. Higher gas prices and panic-buying at petrol stations due to a shortage of lorry drivers, signalled weakening economic growth and hurt market sentiment. By the beginning of the new month, however, Sterling managed to recover, as analysts noted that perhaps the currency overreacted to the fuel crisis in the UK.

The pound rose, leaving behind last week’s losses boosted by Thursday’s release of UK GDP data that showed the economy grew more than expected in the second quarter. This will also offer more evidence that the economy is growing, and the Bank of England is on track to raise interest rates in early 2022.

Sterling is a good buy

Analysts believe that due to its long-term undervaluation, the pound is an attractive investment. In general, economists believe that economic growth will continue, and the economy will return to its pre-pandemic levels in the first quarter of 2022, earlier than anticipated.

Many currency strategists believe that the pound will also strengthen against other major G10 currencies in the short term and even for longer against the euro. The Bank’s earlier raising of interest rates and policy tightening will prove to be fundamental to the British currency’s performance.

If investors find the currency appealing due to its rate, then this will offer further support to the currency. However, global developments that could influence the pound remain a constant risk for Sterling. As we have noted in the past, the pound is sensitive to global economic sentiment and tends to depreciate when global stock markets fall. With concerns about global economic growth weakening and inflation rising, it is not unsurprising if the pound reacts with more volatility.

Higher inflation remains a constant risk for the pound

Economists said that higher inflation in major economies will lead to the gradual depreciation of those countries’ currencies. For example, the US and the UK, along with Canada and Australia are at risk of prolonged higher inflation, which might weaken their currencies compared to other countries in Asia or Europe where inflation remains within normal levels. Talking on Tuesday during an interview, Prime Minister Boris Johnson, said that inflationary pressures will subside as supply increases. He stated: “What you are seeing is demand, growing demand sucking in gas from Russia or wherever, you are seeing demand for lorry drivers globally and that has an inflationary effect and as that clears, as supply meets demand then inflation abates."

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The pound could rise against the euro due to the Bank of England’s optimistic stance as interest rates are now expected to rise earlier than previously anticipated. The pound was also pushed higher as traders looking for a good offer bought a cheaper pound. According to analysts, the pound could reach new highs by the end of this year.

Bank of England and Rate hike

While last week, the pound fell due to inflationary concerns, over the weekend it was higher. With limited economic data the week ahead, the pound will be likely influenced by more news on the fuel crisis, but analysts expect it to remain supported on BoE’s interest rate prospects. The Office for National Statistics has also upgraded its second quarter GDP growth forecast from 4.8% to 5.4%. With the Monetary Policy Committee of the BoE expected to raise the bank rate to 0.25% in May and one more time in 12 months, markets are optimistic.

In a speech that was given to the Society of Professional Economists annual dinner, the Governor of the Bank of England said: “All of us believe that there will need to be some modest tightening of policy to be consistent with meeting the inflation target sustainably over the medium term. Recent evidence appears to have strengthened that case, but there remain substantial uncertainties and we are monitoring the situation closely. The BoE policymakers would need to see clear evidence that the labour market is thriving and employment activity is back to normal levels before taking any action.

Labour market possible scenarios

The BoE governor in his speech, outlined three potential scenarios for the labour market, highlighting the uncertainties ahead, as each of these could influence growth, inflation and monetary policy in different ways. The first scenario revolves around the furlough scheme and how after the furloughed workers return to their old jobs, we are still left with an excess of job vacancies. If these vacancies are linked with shortages of workers in particular sectors, this could push wages higher. This situation could raise the rate of unemployment consistent with stable wage growth. In a second scenario, where demand rises over time, vacancies and unemployment could fall. In the third possible explanation, advertised vacancies could be higher, but some of these could turn out not to be jobs as employers change their mind or postpone hiring.

Tightening monetary policy and bank rate

Governor Bailey has characteristically said that despite uncertainty, the stimulus program will need to unwind, and this will be coupled with an increase in the bank rate. He said: “For most members of the MPC, the outlook for the labour market – as I described earlier – is highly uncertain and to some degree likely to be resolved in fairly short order, and this justified a wait and see approach on policy in view of the continuing belief that higher inflation will be temporary. Within this view, some members put more emphasis on the continuing shortfall in the level of GDP relative to pre-Covid, while others emphasised the continuing direction of travel towards closing that gap and the evidence of cost pressures accompanying the closing. But all of this group were of the view that the stimulus to monetary policy enacted in response to Covid would need to start to unwind at some point, that unwind should be enacted by an increase in Bank Rate, and if appropriate would not need to wait for the end of the current asset purchase programme.”

This means that the Bank is expected to normalise its policy in early 2022 which could support the pound. Analysts view the pound’s recent weakness as temporary and expect it to strengthen in the long-term.

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The pound fell and remains vulnerable to global growth concerns and the ongoing fuel crisis in the UK as analysts fear of a difficult winter ahead. The fuel crisis has sparked concerns that growth will slow down, while rising inflation will aggravate problems. The panic buying of petrol was the result of fears regarding supply chain issues as the UK is struggling to recover from the Coronavirus pandemic.  

150 soldiers prepared to drive tankers

UK business secretary Kwasi Kwarteng has said that military tanker drivers are ready to help with the fuel crisis and transport petrol to stations, as 150 soldiers will be driving tankers within a few days. Despite calls to motorists to stop panic-buying at petrol stations, queues have continued. Kwarteng admitted that the last few days have been difficult, with large queues, but the situation is stabilising and that with soldiers driving the tanker fleet and getting petrol into the forecourts, things will return back to normal soon. In regard to issues in the run-up to Christmas, where people are busier, Kwarteng explained that it was difficult to make any predictions, but, nonetheless, he reiterated that the “situation is stabilising.”

The fuel crisis has generated more concerns about who will have priority access and many unions have requested that doctors, nurses and other essential workers to be given priority access to fuel. The Prime Minister has resisted this. The worst shortages have been experienced in London and English cities with fights and, in one incident in south London, a driver pulling a knife.

The supply chain issue and the shortage of lorry drivers is linked to Brexit and the government has said that it will deal with the driver shortage by providing temporary visas to 5,000 foreign drivers.

Bank of England to raise interest rates

The Bank of England will be forced to raise interest rates to fight inflation. Markets are concerned about the Bank having to tighten its policy against a weak background, with analysts describing it as a “stagflation story.”

The UK is especially vulnerable as it appears to be the hardest hit by the energy and supply chain crisis. The energy crisis is affecting economic activity, while the rising gas prices are a real issue for the currency. With the ongoing energy crisis, the pound will remain under pressure, and once it clears it will be able to stabilise. The gas price surge is also a global phenomenon as Asian countries are also competing for the same supplies. Growing fears of an energy shortage in China have led to Sinopec, an LNG importer, to outbid European competitors.

Traders and analysts are now focusing on the fuel crisis as they are worried about how the UK economy will fare and whether the current crisis is temporary or will last longer.

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The pound was stronger yesterday but dropped slightly today following the fuel crisis. The government has the army on standby to help ease fuel supply problems following days of long queues, panic-buying and pump closures. Analysts warn that this will only offer temporary relief, and that the UK needs to do more to more find a more long-term and viable solution to its current HGV driver shortage.

Analysts have noted their concerns about the impact of fuel shortages on everyday life, soaring energy prices and labour shortages which could eventually dent the UK’s economic recovery.

Petrol supply

Fears of driver shortage hitting fuel supply has led to a surge in demand with up to 150 military tanker drivers ready to deliver to petrol stations which have run dry because of panic buying. There is no shortage of fuel, but simply a shortage of fuel in petrol stations, due to a lack of lorry drivers. While this was expected to have minimal effects, the problem has been exacerbated due to the behaviour of motorists who have rushed to stations panic-buying fuel. The transport secretary Grant Shapps said there were "tentative signs" of stabilisation in petrol stations and the Petrol Retailers Association said that the number of motorists at petrol stations was beginning to calm. As Shapps noted, "Once we all return to our normal buying habits... the quicker we get back to normality." The UK is short of more than 100,000 lorry drivers which has affected many industries, especially food suppliers and supermarkets.

In a joint statement, fuel companies, including BP and Shell, have reassured the public that supplies have not been affected and that demand will return to normal levels.

Higher Inflation Could Help the Pound Rise Higher

In the meantime, the pound is expected to rise as inflation pushes higher and the BoE is forced to raise interest rates. Higher inflation is the result of a combination of factors, including supply shortages and shortages of HGV drivers. While the central bank has stated that inflation is only temporary, there are concerns that it will remain high for a longer period of time.

Bank of England Governor Andrew Bailey has expressed his concerns about the current issues with supplies that have pushed inflation higher, and he noted that the Bank is ready to act if this becomes a long-term issue. He said that higher inflation can be dealt with higher interest rates and that a rate rise before the end of this year is not impossible.

The rising energy prices that have pushed inflation higher are a major concern in the UK, and the question is whether more persistent inflation than expected will prove to be the case and how the Bank of England will change its monetary policy to respond to this. The Bank of England last week warned that their forecast for high inflation at 4.0% will be exceeded. In August, the Bank raised their peak forecast from 3.0% to 4.0%.

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