The UK’s supply problems could push the pound lower despite that the market has priced in more interest rate hikes by the Bank of England for next year. The government has offered temporary visas to fuel tanker and food lorry drivers, and to poultry workers. Britain's ongoing supply chain crisis could threaten the UK’s economic recovery, and combined with higher inflation, it could post serious risks to the pound.

Visas to lorry drivers

With Christmas just around the corner, the government is seeking to avoid disruption and will provide up to 10,500 lorry drivers and poultry workers with temporary UK visas. 5,500 poultry workers and another 5,000 fuel tanker and food lorry drivers will be allowed to work in the UK for three months, until Christmas Eve. The Road Haulage Association said the government’s announcement "barely scratches the surface", and that just offering temporary visa for a limited period "will not be enough for companies or the drivers themselves to be attractive." Director of the HGV Recruitment Centre, Marc Fels, said visas for lorry drivers were "too little" and "too late." The move is, however, a huge step forward in providing a temporary solution to supply chain disruption. The government has also requested from the Ministry of Defence examiners to increase HGV (heavy goods vehicle) testing capacity and sent one million letters to drivers who have an HGV licence to return to the industry. 

Various industries such as supermarkets and food chains have reported shortages of lorry drivers, while fuel deliveries have also been affected, with queues at petrol stations as consumers are panic buying despite calls from the government that the UK has plenty of fuel.

Petrol Crisis

Transport Secretary Grant Shapps has stated there was enough fuel and that people should only fill up when needed to avoid creating shortages. He said there were no supply problems at the six refineries and 47 storage facilities, and that drivers and motorists needed to “be sensible.” With the petrol crisis deepening, ministers have been forced to suspend competition law to help oil companies support petrol stations that are running dry, after days of panic buying. Following a meeting with oil companies on Sunday, business secretary Kwasi Kwarteng agreed to allow companies in the oil industry to work together, sharing information to keep petrol stations topped up.

The panic buying and shortage of drivers has also led the government to consider an emergency plan. The prime minister and senior members of the cabinet will examine “Operation Escalin” after BP reported that a third of its petrol stations had run out of the two grades of fuel, and the Petrol Retailers Association (PRA), said that 50% to 90% of its members were also running out, with more to follow.

Operation Escalin was first conceptualised as part of the planning for a no-deal Brexit, and involves  hundreds of soldiers being drafted in to drive a reserve fleet of 80 tankers. The Prime Minister will consider the Escalin and other proposals on Monday afternoon, in a meeting where ministers will also discuss ways to stop people from panic buying. Shortages could continue if people’s behaviour did not change.

The UK could also face a national shortage of turkeys in the run-up to December, with labour shortages due to Brexit.

 

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Despite Sterling rising yesterday following the Bank of England’s positive tone and the prospect of an early rate hike in 2022, on Friday it fell.

Asian and European stock markets were also down on Friday as well as risk-oriented currencies as the potential default of Evergrande can have significant repercussions on markets.

Pound and BoE

After the Bank of England’s meeting on Thursday, markets have brought their expectations forward as now the BoE is expected to start a rate hike cycle with a first increase in May 2022, followed by a second one in November 2022. While there are still uncertainties ahead for the pound, the British currency is still forecast to strengthen against the US dollar and the euro over the medium-term, as some analysts believe.  

Rate hike expected in early 2022

With markets now pricing in the first rate in the first quarter of 2022, the pound will find support, despite questions about the country’s economic recovery. Challenges will continue to exist, including unemployment and labour shortages that have become more prominent due to Brexit. Some analysts believe that if unemployment does not rise then the Bank’s Monetary Policy Committee could even add a small rate hike as soon as February. With market expectations for a rate hike already priced in, it is likely that the Bank will have to raise rates in early 2022 as it could otherwise create confusion and push the pound lower. For example, big banks such as JP Morgan have brought their expectations forward for a rate rise in early 2022 following the Bank’s announcement yesterday. Capital Economics said: "The Bank is moving closer to raising interest rates. As such, we now think that rates could rise in early 2022, rather than in 2023 as we had previously thought." They also added: "Given the gloomy tone of the recent news on economic activity, we had expected the MPC to place some weight on the downside risks to GDP growth.” However, the Bank’s minutes stressed price stability and the inflation target which remains the same. The Bank highlighted that growth uncertainties were external and depended on global supply chain limitations.

For Sterling, any news about when the rate hikes will start or the vote on QE will be key. Both Dave Ramsden and Michael Saunders voted to lower the purchase rate to £840bn instead of the £875bn. The fact that two policymakers want to tighten the policy is important.

Earlier interest rate hikes will offer more support to pound

With interest rate expectations and a first rate to take place for Q1 next year, the pound is expected to find support. It could rise even further if such expectations move even more forward.  While raising interest rates might not affect inflation, what other Central Banks do does have an effect on global markets and policy. The ECB and the Federal Reserve have both announced that they will begin the tapering and reduce their stimulus support, and if the Bank of England does not follow suit the pound could go lower, something that could push inflation to rise and import prices to go higher.

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The Bank of England remains on track to raise interest rates in the first half of 2022. The pound rose against the euro and US dollar following the bank’s update to keep rates the same. The Monetary Policy Committee voted 9-0 to leave the Bank rate at just 0.1% and to maintain its quantitative easing bond-buying programme at £895bn. Deputy governor Dave Ramsden and Michael Saunders, voted against this, as they wanted to stop the QE programme early by reducing the amount of UK government bonds the BoE buys. While the bank was not 100% yet positive as there are uncertainties about the global economy and the labour market, the pound is expected to regain some of its losses but not to climb to new highs.

According to Bloomberg, City traders have revised their forecast for the first interest rate to 0.25% after the Bank of England’s outlook for the UK economy has improved and that tightening of its QE programme could commence soon.  After Thursday’s meeting, markets now expect a 15-basis-point increase in March 2022, a month earlier than their expected one for May. They also expect a rise of 0.5% in November 2022. With markets now pricing an increase in March and two hikes by the end of next year, investors will be focusing on the bank’s November meeting when a new set of forecasts will be announced.

Inflation

The Bank of England has warned that inflation will rise above 4% by the end of this year, due to the energy crisis. The rise in gas prices is considered a risk to its projections for inflation and it has warned that inflation could remain above 4% into the second quarter of next year making things harder for households. The MPC expects that global cost pressures would prove temporary.

Growth forecasts lowered

The Bank of England has lowered its growth forecasts as supply chain problems are impacting output. Expectations for growth in the third quarter have been revised from 2.9% to 2.1%. The Bank has warned that supply problems such as access to raw materials and staff shortages are affecting economic growth. The Bank also highlighted that global recovery has lost momentum and inflationary pressures will continue.  

Tightening monetary policy

The case for tightening monetary policy seems now stronger. Consumer price inflation rose to 3.2% while global cost pressures and supply problems are pushing consumer goods prices higher. CPI inflation is expected to fall back to the bank’s 2% target in the medium term, but the bank has also pointed out that: “Indicators of households’ medium-term inflation expectations have increased in recent months, with the Citi/YouGov five-to-ten year ahead measure at its highest level since 2013 in September.”

The BoE is also under pressure, as other central banks such as the ECB and Federal Reserve have announced that they will begin unwinding their financial support. If the BoE does not act in the same timeline, Sterling could fall, pushing inflation and prices higher. A rising pound will push the cost of imports lower and will act as a deflationary force.

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The pound was lower on Wednesday after investors became less confident about an earlier rate hike by the Bank of England, which is now likely to be delayed due to weak economic data. A weak US dollar and a stronger risk sentiment following news that Evergrande would repay a yuan-denominated bond on Thursday have not helped to support the pound.

Risks for the pound

The main event for the pound this week is Thursday’s Bank of England decision, and investors seem to have moved from expecting a hawkish BoE to grasping the fact that an interest rate hike is now more than six-months away due to the release of disappointing economic data. The currency market is expecting at least two rate hikes by the end of 2022, but now such expectations are considered too optimistic. With the market pricing the fact of an earlier interest rate for some time now, the realisation that the tables have turned, and a rate hike might take a while longer, means that the pound could react by falling. Sterling could find support if the BoE clarifies its timeline for raising rates starting early next year, but this is unlikely, analysts have noted. The Bank’s expectations will also be shaped by the health of the labour market, especially after the furlough scheme is completed at the end of this month, and analysts expect unemployment to rise. The BoE will also take into account disappointing data for July, retail sales’ numbers in August, and high inflation.

The pound was also weaker against the euro as investors are waiting to hear form the Federal Reserve any hints on the direction it will take for its future policy, including whether it will start tapering its bond buying by November.

Factors that could support the pound

The possibility of Britain joining the North American free trade deal, an idea that has been shared by media, could boost UK-US trade and help offer support to Sterling. As a UK government figure said, the UK is interested in pursuing this option but “The ball is in the US’s court. It takes two to tango.”

The trade partnership between the US, Canada and Mexico, is now a possibility after Boris Johnson failed to secure a bilateral deal with Washington. It appears that a direct free trade agreement (FTA) with the UK is not something that the president Joe Biden will be interested in pursuing and the Prime Minister said that Biden “has a lot of other fish to fry.”

The UK government’s interest in joining the North American deal follows the opening of talks for the UK to become a member of the CPTPP Pacific trade group. The likelihood of Britain joining NAFTA is an attempt to secure a tariff-reduction deal as new barriers have been erected to trade with the EU with Brexit.

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The beginning of the new week has seen the pound fall as market sentiment deteriorated following fears the Chinese property sector will suffer from the Chinese mega developer Evergrande’s collapse. Additionally, fears of a global economic slowdown and a gas crisis have left the market in a risk off mode, with the pound lower against the safe havens of the US dollar, Yen and the Franc. Sterling was also lower against the euro and commodity currencies including the Australian dollar, New Zealand dollar and Canadian dollar.

Energy markets

The UK’s wholesale energy markets have risen recently due to a global increase in demand for gas after a prolonged cold winter that left gas storage facilities depleted, with increased energy demand across Asia. Prices have surged as a result of a global attempt to refill gas storages before the winter.

With half of the UK’s electricity coming from gas-fired power plants and a rising demand for gas power after a series of nuclear reactor outages and the recent closure of a major power cable that brings in electricity from France, the situation has generated concerns about the coming winter months.

The UK government is also taking part in discussions about a possible financial bailout to energy providers. Kwasi Kwarteng, the Business Secretary, has been in various meetings over the weekend and will continue to meet the heads of energy businesses this week, to explore the possible options amid warnings that many companies could go bust. One of the potential solutions that have been discussed is a bail-out fund and the industry is now fearing a financial collapse according to the FT.

Following his emergency meeting with energy companies on Monday, Kwarteng  tweeted that he will update MPs this afternoon, and that the government is looking at different options to protect customers and to they have continuity of supply if their supplier fails, through a “Supplier of Last Resort” or a special administrator if needed. The energy price cap will remain in place he confirmed. A spokesman for the Prime Minister told reporters: “The price cap remains in place, as I say, to protect consumers from sudden increases in global gas prices and it will save them money this winter.”

With the possibility of millions of customers being unable to be served by failing companies, supply energy companies are requesting support from the government, and a "Northern Rock-style bad bank" could be created to house such customers without losing money.

BoE

The gas crisis comes ahead of Thursday's Bank of England policy meeting which is a crucial event for the pound. The Bank could warn the gas crisis could slowdown growth and possibly push back the timing of an interest rate hike.

Evergrande

Another event that has rattled the markets was the news that the Chinese mega developer Evergrande is heading for a corporate restructuring that could see investors lose tens of billions of dollars. Shares in Evergrande have plunged 17% and the group’s massive debt problems could trigger a broader sell off across all financial markets. Evergrande's importance to the Chinese economy is huge, as its debts amount to around $447 billion (US$315b). This is more than three times the entire debt load of the New Zealand government and two-thirds of all outstanding Australian federal debt.

The rising natural gas prices and the energy crisis, the potential of produce shortages and surging inflation have already painted a rather dire image of the global economy. The Fed’s meeting this week and the German election create further uncertainty.  Monday’s major shock for the markets came from Evergrande’s meltdown and investors could possibly avoid China. These are now being factored in by the markets, and it will be especially revealing to see how the Fed will position itself in terms of another rate hike amid inflationary pressures.

The pound has hit a four-week low this Monday as investors turned to safer assets, but GBP currency traders will be looking at this Thursday’s BoE meeting for more guidance.

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Analysts are positive that the pound will likely continue to strengthen in the coming days and even weeks, after encouraging news that the economy should show strong growth in the third quarter and the Bank of England is considering raising interest rates in early 2022.

Growth is expected to continue

Friday’s disappointing GDP data which showed that the economy grew very little did not affect market sentiment, as economists argued that many of the reasons behind the slowdown were associated with the past including self-isolation rules. August and September GDP numbers are expected to be stronger, confirming expectations that the economy is healthy. Economic thinktank NIESR has forecast that UK growth will have picked up in August and September, due to the domestic tourism and hospitality industries, with September’s growth to rise to 0.8%.  

The pound was higher against both the euro and the US dollar on Monday morning, as markets are confident that the BoE could move faster than both the ECB and Federal Reserve and raise interest rates early next year. This will also depend on positive economic data coming out of the UK and investors will want to see consistently positive news before they become confident about the strength of the UK currency.

On Friday, the pound reached a two-week high, following its previous lows, but fell again after global sentiment was threatened by rekindled fears regarding the troubled relationship between the US and China.

Bank of England and rates

The Bank of England is expected to raise interest rates in the first half of 2022 due to improved economic conditions including growth rates and rising inflation. Economists are concerned that inflation will rise above the Bank’s target and for a longer period of time, which could lead to further interest rate rises. This will help boost the pound too.

The Bank of England appears to be more positive and ready to push interest rates higher than many other central banks such as the Swiss National Bank, the ECB and the Bank of Japan.  Following last week’s Monetary Policy Committee members’ appearance before a Parliamentary sub-committee and the revelation that half of the members are already convinced that the minimum conditions for an interest rate hike have been met, the pound has strengthened.

If the recent uncertainty caused by the rapid spread of the Delta variant of the coronavirus proves to be temporary, then the pound will find further support. Economists are still cautious about the pound considering the return to school and the possibility of more cases. The winter is also a concern, and with the number of high cases continuing, consumer spending could be affected. With or without any new restrictions, activity could still suffer as consumers become more cautious. Bloomberg has also highlighted the ending of several government support programmes this month that could weigh on sentiment.

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The pound rose in response to Bank of England Governor Andrew Bailey’s comments that a 2022 rate hike is possible. While soon after, the pound was unable to hold its gains, the revelation by the central bank was important as it confirmed market expectations that a rate rise in the first half of 2022 is possible.

UK tax hike

The pound was higher, especially after it lost ground due to an announcement on Tuesday of a UK tax hike. The proposal, which on Wednesday was backed by British lawmakers in a parliamentary vote, intends to raise taxes to fund the health and social care systems. The government will raise the rate of National Insurance payroll taxes paid by both workers and companies by 1.25 percentage points. The tax on shareholder dividends will also rise by the same percentage. The plan is expected to help raise 12 billion pounds ($17 billion) a year.

Bank of England Vote to Raise Interest Rates

Andrew Bailey clarified that the eight members of the Monetary Policy Committee (MPC) were divided as to whether the UK economy was healthy enough for interest rates to be raised. In a testimony to the Treasury Select Committee of the House of Commons, Bailey noted that the vote was split: “Let me condition this by the fact that it was an unusual meeting because there were only eight members of the committee - so it actually was four-all.” In the August MPC meeting, however, all 8 members voted to keep interest rates unchanged. So, the bank feels more confident about the state of the economy now. Nonetheless, Bailey explained that the

Bailey said that the conditions were not yet sufficient. Markets expect the MPC to end quantitative easing in December before proceeding to raise interest rates. While Silvana Tenreyro did not believe that the conditions have been met yet, other members of the MPC including Bailey, Dave Ramsden and Ben Broadbent and Michael Saunders, all believed that the minimum conditions had been met for a hike. The remaining members of the MPC, Gertjan Vlieghe, Jon Cunliffe and Jonathan Haskel were possibly the more dovish members who believe that conditions have not been met yet.

Has the 2022 interest rate already been priced in by markets?

It would appear that it has been priced in by markets, as the pound was unable to hold gains. For the pound to strengthen, the Bank will need to provide more evidence of future rate hikes. If inflation stays above the Bank’s 2.0 % target, then the need to raise interest rates will rise too. The Bank’s economists expect inflation to rise 4.0% in 2021 but fall back in 2022. Bailey said that some issues could disappear, but unemployment and job vacancy issues could persist. Higher commodity prices and problems with supply chains could go away, but the labour market will need to improve consistently.  

Economists are concerned that after the end of the government's furlough scheme, unemployment will rise. But with many businesses finding it difficult to fill in their vacancies, the end of the support program might be positive.

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Sterling fell on Tuesday against a stronger dollar, following a drop at the start of the week due to the UK’s economic slowdown.

Weak surveys push pound lower

While earlier this year, markets were upbeat about the UK’s economic prospects as the fast pace of the Covid-19 vaccinations injected confidence about reopening the economy and a quick economic rebound, more recently indications of a slowdown have pushed the pound lower. Additionally, the combination of factors such as Covid-19 that forced lots of employees to stay at home and hurt businesses, as well as global supply issues due to Brexit, have also drove the British currency lower.

On Monday, it fell after a survey of purchasing managers showed that the UK construction industry was hurt by a shortage of building supplies which weakened its growth last month. Friday’s PMI data also showed that growth in the services sector slowed down in August compared with July.

Bank of England’s Michael Saunders

The positive comments by Bank of England’s policymaker Michael Saunders did not have a significant effect on the pound. Saunders said the central bank may need to raise interest rates next year if both growth and inflation continue to rise. His comments did not surprise markets as investors possibly do not consider him as an influential voice of the MPC (Monetary Policy Committee).

Saunders believes that the Bank could stop its stimulus programme and that the continued purchases could put inflation expectations at risk. In an online event hosted by Intuit, Saunders explained why he voted to reduce the Bank’s QE bond-buying stimulus programme at last month’s MPC meeting: “My own view at the August meeting was that with the recovery in the economy, and inflation back to target, we no longer need as much monetary stimulus as previously.”

He also noted that interest rates could rise when the health of the economy is undeniably strong: “As to when I think interest rates might rise, that would depend on the economic outlook.” He added: “If the economy continues to recover, and inflation shows signs of being more persistent, then it might be right to think of interest rates going up in the next year or so. But that is not a promise and depends on economic conditions.” In relation to inflation, Saunders said that he was worried “that continuing with asset purchases, when CPI inflation is 4% and the output gap is closed - that is the likely situation later this year - might well cause medium-term inflation expectations to drift higher. Such an outcome could well require a more substantial tightening of monetary policy later, and might limit the committee’s scope to respond promptly the next time the economy needs more stimulus.”

Saunders argued that the UK economy has recovered and that the pandemic’s effects will prove to be minimal in the log run. Brexit, on the other hand, will have long term repercussions. For him, ending the current asset purchase programme would not hurt economic recovery as it would still  leave a “very supportive monetary stance in place.”

Last month the BoE said that it could start reducing its financial support which was so necessary during the Covid-19 pandemic and lockdowns, and it has explained how it will do so after it has raised interest rates.  

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If strong domestic data confirm expectations that the UK economy is growing, then the pound could rise higher. According to a recent UK business activity survey, the August Bank holiday weekend is expected to push business revenue higher as more consumers flock to the shops.

Sterling will remain volatile due to global developments and concerns about the spread of the new Covid variant, but UK economic growth and Bank of England policy will also be key drivers of the currency. The release of better-than-expected economic data will offer much needed support to the economy and the pound.

Pound sentiment suppressed due to labour market concerns

Concerns that a labour shortage could impact on the UK’s economic recovery have been expressed in the quarterly survey from the Confederation of British Industry (CBI). A quarterly survey conducted by the CBI from July 29 to Aug. 16, showed that optimism was at minus 17% this month, down from May’s 47% as companies struggled to bounce back after the pandemic. Charlotte Dendy principal economist for the CBI, said on Thursday that “Firms in sectors such as hotels, restaurants and travel do not expect this strength to persist into the next quarter, reflecting the pressure that consumer services firms continue to face.” Labour shortages could weigh on businesses’ investment plans for the next 12 months.

For services businesses, there are added costs and higher wages after the pandemic that they need to resolve, while Brexit has made it more difficult to access talent from the EU. An index tracing the outlook for costs showed that it has reached the higher in two years and is starting to filter through to the prices, with average selling prices rising at the fastest rate since 2019.

Bank of England interest rate hike

The Bank of England is expected to raise interest rates in 2022, but analysts say that for the pound to rise higher in a sustained manner it will take an earlier hike, or more than one interest rate rises after 2022. Markets are hopeful that the economy will expand, and the labour market improve in order to see any substantial shift higher in the pound’s performance.

Short-term pound volatility

Federal Reserve Chair Jerome Powell's speech to the Jackson Hole economic conference on Friday will possibly offer few new hints about ending its quantitative easing programme. If it does show any clear indication that it intends to proceed with tapering the $120 billion in monthly purchases of Treasuries and mortgage-backed securities, then this will have a negative impact on global economic growth, but it will be supportive of the Dollar. If the Fed indicates that they are not yet ready to proceed to reduce its massive asset purchases, as the delta variant continues to spread rapidly igniting further fears of an economic slowdown, then the US dollar will fall. As Goldman Sachs economists have said earlier this week, Powell will be cautious not to lock in a specific date for starting the taper and he would keep the possibility for starting in November open.

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The weakened global investor sentiment has kept the British currency under pressure against both the US dollar and euro. Analysts believe, however, that this will only be temporary as has already been seen throughout the last year. Fears of a global economic slowdown due to the pandemic and the spread of the Delta variant in Asia, as well as expectations the Federal Reserve will withdraw stimulus have hurt global sentiment.

The pound is mainly impacted by Bank of England policies and domestic economic developments but also by global investor sentiment. As it stands, there is a risk-off/risk-on binary which is affecting the foreign exchange market. Pro-cyclical currencies such as the AUD, CAD, and NZD tend to appreciate during good times, as opposed to countercyclical ones which appreciate in bad times. In a risk-off world where traders are not optimistic, and want to avoid risks, such currencies as the AUD and NZD become more vulnerable. In the current situation, the spread of the pandemic and the rapid rise of the Delta variant in Asia has hurt these pro-cyclical and commodity currencies as their main trade partner is Asia.  The pound is also sensitive to global risk sentiment. The trajectory of the pound will then depend on investor sentiment.

Market sentiment: Factors to consider

The main concerns for markets are as we mentioned the Delta variant’s spread in Asia and worries about the Federal Reserve withdrawing financial support. These concerns have prompted traders to wind back their bets on a strong economic recovery. With the general sentiment being cautious and nervous, the pound is under pressure, while the US dollar has strengthened.

  • Federal Reserve

The Fed is expected to announce a reduction to its quantitative easing programme some time between the Jackson Hole Symposium and September. This will open the way to a rate hike towards the end of 2022 and beginning of 2023. The news has now pushed the US dollar higher, whereas the pound is as low as it was the end of July.

  • Fears of slowing economic growth

The expected taper to the Fed’s programme combined with fears of slowing economic growth as Asian economies grapple with rising Covid cases has clouded market sentiment. The two factors are interrelated, as economies are currently dependent on and expectant of support from their central banks. With the Fed withdrawing support and the Delta variant spreading across Asia and hurting economic growth, the question is whether this is just a temporary concern. For analysts this won’t change markets massively and that the Fed’s anticipated tapering has already been priced in. The Covid threat has been there and continues to affect markets, and any weakness is seen by traders as an opportunity to buy cheaper assets.

So, this is seen as history repeating itself, with the pound’s weakness being just temporary.

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