May is expected to bring some volatility for the pound which can be a good thing for traders of the currency. The first week of May will be an important one for the pound as on the 6th of May, the Bank of England (BoE) will deliver its monetary policy decision and its quarterly Monetary Policy Report. Investors and analysts are also expecting the Scottish election to be a pound-sensitive event as it could result in a majority for pro-independence parties. In the near term, both events could affect the pound and set the tone for currency trading throughout the last month of Spring.

A hawkish tone from the bank could weigh on the pound

Economists will be closely watching the BoE’s upcoming meeting to understand whether the bank will change its quantitative easing programme by reducing its rate of asset purchases.  This is seen as a necessary measure to provide liquidity to the economy, and it will open the path for raising interest rates in the future. For this reason, if the bank decides to make such a move, markets will be pleasantly surprised, as three months ago the bank was seriously considering pushing interest rates into negative territory.

While such a move is welcomed and appropriate since the economy is recovering, it is still too early, and some economists believe that the bank will not be raising interest rates anytime soon. The BoE is more likely to remain cautious, and this might put some pressure for the pound. While the market expects interest rates to remain unchanged, they are not quite sure about the bank’s intention to reduce quantitative easing. For some analysts, there are concerns about the pandemic and unemployment which could rise following the withdrawal of the government’s support.

Scottish elections

Scotland will be voting for the next Holyrood parliament on 6th of May and political commentators say a strong result for pro-independence parties will inevitably lead to another independence referendum. However, financial analysts do not expect the Scottish elections to have a major impact on GBP. Regardless of the result, most experts do not believe this will immediately lead to an imminent vote for independence, as a second independence referendum is probably years away.

As things stand, it is also unlikely that Prime Minister Boris Johnson’s government will grant consent to hold a second referendum.  While who holds the power to allow a vote could ultimately be tested in the courts, at the same time the probability for an imminent referendum is small. A refusal from Boris Johnson could also further strengthen pro-independence sentiment in Scotland. The possibility of a second independence referendum is not going to go away and will play a key role in the next UK-wide general election in 2024.

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Concerns about the Covid-19 pandemic are weighing on the markets and have impacted on global investor sentiment again, amid a surge in coronavirus cases in countries such as India and Japan. This has also pushed the value of Pound Sterling against the Euro and Dollar lower, confirming that global market sentiment will need to improve to boost the pound.

Yesterday, European markets also experienced their biggest fall this year, with airlines and hospitality firms severely affected. The pan-European Stoxx 600 lost 1.9% and the London FTSE 100 lost 2%.

The release of ONS data on Wednesday morning has done little to change things. UK consumer price index (CPI) data showed that the inflation rate rose to 0.7% in March 2021 from 0.4% in February. This is the first increase from fuel prices since February 2020 which helped drive the increase in March. UK CPI inflation rose by 0.3% m/m. However, in the long-term, increases in several of the producer price index (PPI) numbers signal potentially more inflation in the future which will be positive for GBP, as this will drive the Bank of England to tighten UK monetary policy.

Weaker pound

The pound is generally affected by global market sentiment and it traditionally benefits when the global economy is growing, and investor sentiment is positive. This is why declines in the stock market are reflected by similar declines in the pound. While positive economic releases can have a beneficial effect on the pound, the global conditions can overshadow such domestic data.

The pandemic has had a massive impact on the pound’s travails, and this is also what is happening right now as risk appetite has been under pressure with the number of Covid-19 infections rising in Asia. The WHO said that the number of cases has surged in all regions except Europe. In Japan, Tokyo and Osaka have asked the government to declare a state of emergency from 29th of April 29 to 9th of May 9.

FX analysts at Bank of America have said that “a pro-cyclical, risk-on environment should be GBP supportive as it will for other high beta currencies. What will see GBP standout is whether the UK can continue to attract investment inflows, which have been a hallmark of the recent appreciation."

UK Inflation Data

The release of inflation data has not influenced the pound, as investors are waiting to see how the country manages to move back to normality. Investors will be more interested in Friday’s release of PMI data for April, as it will offer a clear picture of how strong the rebound has been after reopening businesses on the 12th of April.

Wednesday’s release of inflation numbers showed that the annual CPI inflation rate has gone from 0.4% in February to 0.7% in March according to the ONS, and it was driven by a 0.3% month-on-month rise recorded in March.

"The UK has reached a turning point in its economic reaction to the pandemic where price growth is now on an upward trajectory, and should remain so for some time to come. Year-on-year consumer price growth slowed to 0.4% in February from 0.7% in January, primarily due to falling prices in clothing and footwear," Paul Craig, portfolio manager at Quilter Investors said. He added: "From here, inflation may tick markedly higher if the steady drip of consumer spending morphs into a waterfall as lockdown restrictions are lifted and households spend some of their accumulated pandemic savings.”

The UK will need a bit more time to recover and the economy to become more normalised until the Bank of England will consider raising interest rates. The Bank of England has stressed that the economy will need to reach pre-pandemic levels and the inflation target to be met, before it makes any move.

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Sterling will continue to rise in the coming months, analysts are expecting, but they also warn a period of pause for the currency in the near term. Investors will be closely watching the release of crucial economic data this week as well as the next ones to find more evidence about the economy returning back to normality. With employment data out on Tuesday, inflation and PMI numbers out on Wednesday, and retail sales out on Friday, the current week will be a busy one.

Vaccination programme

With the vaccination rollout going smoothly and the UK being ahead of the rest of Europe, investors are waiting to see that the economy is improving. Any advances in Sterling during the coming months will be indicative of the country’s economic recovery and that the UK is exiting the pandemic in a sustainable manner due to the fast pace of the vaccine programme. Unlike the UK, Covid cases in Germany and France are rising and resulting in extended lockdown measures.

EU-UK trade deal

Also helping the pound is the renewed certainty in the government and Brexit after December’s trade deal. As economists noted, "We expect the Brexit deal will eventually reduce the uncertainty which has been weighing on especially UK businesses over many years now after the near-term adjustment to the new relationship is over. We believe Brexit has moved into the background now.” With less risks and more stability, the pound will continue to rise, however, analysts are cautioning that the currency might find it difficult to maintain its appreciation pace in the coming days and weeks. Especially, after the BoE kept a cautious tone and did not raise interest rates, despite recent positive data, markets might have already priced in the positive news and the pound might get stuck for a while. For many analysts, there is still hope, as the pound could move higher when it becomes clearer that it has exited the pandemic unscathed and strong.

In other words, the near-term pound behaviour will mostly depend on the economic data and whether there are strong numbers to boost market confidence. The coming weeks will be crucial in that regard.

UK economic data

Tomorrow, the release of UK employment data for December and inflation numbers on Wednesday will be closely watched by investors. After losing -114k jobs in November, the latest reading is expected to be disappointing indicating a loss of -170k jobs. These job losses are coming despite the extension of the furlough scheme into September.

The inflation numbers for February are expected to rise to 0.8% from 0.7% but the market will expect a higher move. A higher UK inflation number would then put pressure on the Bank of England to bring forward its rate hike plans when the economy reopens in June.

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After a dovish performance from the US Federal Reserve yesterday, investors have been waiting to see what the Bank of England thinks about the UK economy. Economists were expecting the bank to signal that it will raise interest rates, something that would help to extend the current Pound Sterling rally. However, the bank has disappointed by announcing that it will not raise interest rates until inflation is under control and has risen considerably.

The Pound has strengthened in 2021 after the bank confirmed that it won’t take interest rates into negative territory and the assumption now was for the bank to raise them and support the pound.

Bank remains cautious

However, while economic recovery and the vaccination programme have offered a positive outlook, the bank chose to maintain the current pace of quantitative easing (£4.4bn weekly) and reach its inflation target. The bank said that "The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress has been made in eliminating spare capacity and achieving the 2.0% inflation target.” After the employment fell during the pandemic the Bank expects it to recover so that rising wages start pushing inflation higher. The bank’s decision reflects a more cautious stance as it prefers to wait and see how things develop and whether inflation rises above 2.0% as employment recovers closer to pre-pandemic levels.

The pound fell as investors and traders were expecting a more hawkish tone from the bank.

Bank expectations

The Bank noted that recovery from April 2022 onwards will slow down due to the March Budget which will create a medium-term fiscal tightening. They stated that there is little hope that CPI inflation will rise above the target at the end of this year. According to Samuel Tombs, Chief U.K. Economist at Pantheon Macroeconomics: "The MPC chose not to push back against the recent rise in rate expectations and gilt yields. This was never likely, given that the first rate hike isn’t fully priced-in by markets until Q1 2023; the Committee can’t make credible commitments that extend so far into the future.” Tombs added that interest rates will be raised soon as long as the markets recover. More generally, though, the Bank of England appeared to be less gloomy about unemployment and that a more resilient than expected economy will help improve the employment landscape.

BoE: signs of economic recovery

While the Bank of England’s MPC voted 9-0 to leave interest rates and QE unchanged, there are several signs that point that the economy is improving. Since the MPC’s previous meeting, the near-term economic activity had been positive. The issue now is whether companies and households will increase their spending once the lockdown ends or whether they’ll be cautious. Minutes of the meeting said that Rishi Sunak’s decision to extend the furlough until the end of September has also helped to change the outlook for the unemployment rate.

Indeed, Hugh Gimber, global market strategist at J.P. Morgan Asset Management, highlighted that the economic outlook has improved as “the Monetary Policy Committee is feeling a little more comfortable about the prospects for the economy than at its last meeting six weeks ago. The latest budget confirmed that government lifelines for the labour market will continue, the vaccine rollout is progressing at pace, and a gargantuan stimulus package across the Atlantic should have positive spillover effects across the globe. Against this backdrop, the UK economy is poised for a strong rebound this year.”

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The pound strengthened against the euro, due to positive market sentiment as a result of the intense and ongoing vaccination rollout programme. Goldman Sachs has speculated that the pound could even rise further against the euro.

Rishi Sunak’s Budget announcement boosts sentiment

Following the budget announcement, the Wall Street investment bank told its clients to trade in Sterling as the UK economy is expected to grow in the coming months.  UK Chancellor Rishi Sunak’s budget announcement last Wednesday revealed spending and taxation plans that were better than expected. Sunak announced that an additional £65 billion will be provided for spending, grants and tax breaks with the total additional spending and benefits reaching £352 billion. "The UK economy is well-positioned for the coming recovery," Goldman Sachs’ Zach Pandl said. "The support program laid out by the government surprised consensus expectations to the upside, and included a number of economic incentives aimed at medium-term investment." Most economists believe that supporting the economy generously during the covid crisis will help the economy grow stronger faster and avoid any long-term negative effects.  

Vaccination programme also offers support to pound

Goldman Sachs’ economist Pandl also noted that the UK’s vaccination programme has helped the economy. He said: "Solid household and business balance sheets should soon translate into robust growth, as the UK’s strategy of prioritising getting more people vaccinated with a single dose appears to be paying dividends. We are therefore keeping open the short EUR/GBP component of our long GBP/CHF cross trade.”

Britain has outperformed on its vaccination programme, especially when compared to other European countries, with more than 21 million people having received the first dose of a Covid-19 vaccine.

UK business confidence hits 12-month high

The UK’s fast vaccination programme has also had a positive effect on businesses’ confidence. According to the latest Business Trends report from accountancy and business advisory firm BDO LLP, service sector confidence jumped in February to its highest level since the pandemic began.

BDO’s Services Optimism Index rose to 94.13 in February from 86.60 in January, back towards the long-term average of 100. This is the highest reading in 12 months for the survey, which covers a a wide range of industries from retail and hospitality to professional services.

Also, according to polling firm YouGov, British consumer confidence has risen to its highest level since the coronavirus pandemic started, according to polling firm YouGov. YouGov reported that  consumer confidence rose to 105.4, driven by expectations for house prices, business activity, and household finances over 2022.

The governor of the Bank of England, Andrew Bailey, has also expressed optimism about the economy but also cautioned for unrealistic expectations, as life will not return to pre-Covid levels. He noted that there is a “growing sense” of economic optimism building. He said that Covid has hurt demand and supply which some of the structural changes in the last year will not really change.

Bailey said: “The best we can say is that how the output gap develops in the recovery from Covid will depend on the net effect of the two [demand and supply], both of which will need to move by more than in normal recoveries. There is another element to this part of the story which is hard to assess at present, namely to what extent the more structural changes we have seen during the Covid crisis will persist, and what effect they will have on the recovery? In general, however, economists remain optimistic and the pounds recent surge owes a lot to the government’s successful vaccination programme.

 

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The UK’s successful vaccination rollout programme, along with the BoE’s decision not to lower interest rates, have boosted market sentiment about the UK’s speedy economic recovery and pushed the pound higher. The pound is trading almost close to a nine-month high against the euro, and at a 33-month high against the dollar. It is almost getting closer to its highest levels in over three years.

Rabobank’s Jane Foley said: “GBP bulls have been flexing their muscles since the start of the year based on relief about the EU/UK trade deal and on hopes that the relatively rapid vaccine roll-out programme will lead to a fairly fast economic recovery this year.”

Weaker dollar

The pound’s strength is a result of it capitalising on the US dollar’s losses. The prospect of a major new US stimulus package has weakened the dollar, which continued to fall lower after last week’s disappointing US payrolls report. The wider increased confidence has turned investors away from the safe haven dollar and towards riskier assets.

JP Morgan explained that "The broader USD continues to trade with a much softer tone, drivers seem to be the relentless CNH bid into Chinese New Year and the fact that US yields backed aggressively off key levels and have now calmed down." According to JPMorgan, the USD selling by Chinese traders has also push the dollar lower, a move that is highlighting the importance of the Chinese Yuan in broader market movements.

The past three days’ weakness of the dollar shows that the recent dollar rally has come to an end and that the trend of depreciation has come back into play. JP Morgan said: "We added to our modest sterling longs yesterday via GBP/USD and look for this move to keep going at least until the end of the week (Chinese New Year on Friday).”

Quick vaccinations and market optimism

The UK economy might experience its troubles, but the swift pace of vaccinations suggests that economic recovery will be stronger and faster. The vaccination programme will soon impact health outcomes and boost the Bank of England’s positive outlook. If the Bank shows further optimism and investors are upbeat about economic prospects, then the pound will rise higher.

The general positive market sentiment has helped the pound, as it has become linked to risk appetite during the crisis.

With downside risks for Sterling expected and priced in, analysts see further potential for the pound as the vaccination rollout continues strong. As NatWest Markets analysts said, a "quicker pace of vaccine roll-out will likely lend support to Sterling.” However, they expect any pound increases to be short-lived, as the UK economy struggles post-Brexit.

The Bank of England has said that a strong economic rebound is possible once the lockdown restrictions are lifted and consumers start spending again.

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The British Pound has risen following comments by the Bank of England's Governor Andrew Bailey that the rate will not be cut to 0% or below in the coming weeks. With the ongoing vaccine rollout and positive market sentiment about a quick economic recovery, the Bank appears to be willing to wait and see how the UK economy fairs before taking interest rates into negative territory.

Vaccine rollout

The government has promised to vaccinate 15 million people in the top four priority groups over the next five weeks and 17 million more in the five remaining groups by spring. According to the government’s immunisation plan, fifty special vaccination centres will support hospitals and doctors to provide 2 million jabs a week by the end of January.

The inoculation plan was unveiled on Monday as the NHS announced that 866,000 people in England were vaccinated the first week of January. On Monday, seven national vaccination centres opened in England, as well as 200 hospital sites and many GP centres. 50 more special centres will open by the end of the month. Many GPs believe that the 2m-a-week target can be achieved, despite MPs’ complaints in the parliament that the supply was chaotic.

More Vaccinations, Stronger Pound

The more people are vaccinated, the sooner the pandemic will be controlled, and the economy will recover. If everyone is strong and healthy, then the body of the economy and the country will also be strong and healthy. This will ensure a robust economy and will affect whether the Bank of England changes interest rates and its quantitative easing programme. If the BoE chose to lower interest rates, this would have been with the aim of stimulating lending and injecting a flow of money into the economy during the lockdown. However, such drastic measures would have pushed the pound lower. 

The governor of the BoE highlighted that there were too many concerns about negative interest rates, and that members of the Bank's Monetary Policy Committee debated their possible benefits. He has also warned that negative interest rates may hurt economic recovery and he appeared to be against such a move followed by such countries as Sweden, Denmark and Japan. He said: there are “a lot of issues” when considering using negative interest rates as a fiscal tool: “At first glance they are counter-intuitive.” He added: “First of all, no country has really used negative interest rates at the retail end of the market.”

There is, however, growing speculation after the recent comments by Silvana Tenreyro, a member of the Bank’s rate-setting Monetary Policy Committee, that using negative rates is a possibility and can be done without depriving the banking system. Interest rates have been at a historic low of 0.1% since last March in an attempt to protect the economy from the pandemic. If the possibility of negative interest rates is slowly reduced in the coming weeks, the pound is expected to get a further boost.

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The possibility of the Bank of England pushing interest rates into negative territory has been hinted at by a member of the BoE’s Monetary Policy Committee. If interest rates go lower, it is expected that the pound will be negatively impacted in the next few months. The decision to use negative interest rates is considered by the bank as positive in regard to offering further support to a struggling economy.

MPC member Silvana Tenreyro said in an online speech that negative interest rates will boost UK growth and inflation. "Cutting Bank Rate to its record low of 0.1% has helped loosen lending conditions relative to the counterfactual (of no policy change), and I believe further cuts would continue to provide stimulus," Tenreyro noted. Tenreyro said the Bank of England has been in contact with financial services firms discussing the potential impact of negative interest rates. She said: "Once the Bank is satisfied that negative rates are feasible, then the MPC would face a separate decision over whether they are the optimal tool to use to meet the inflation target given circumstances at the time."

How has the pound performed in 2021?

The pound has not enjoyed a good start to the new year, as it dropped against the euro and the dollar. The fact that the UK and EU reached an agreement on Christmas Eve has not made the situation better either, despite the hopes of some economists. Additionally, they are increasing concerns about the economy due to the stricter lockdowns. This has raised expectations of a further interest rate cut by the BoE.

The possibility of lower interest rates will also make UK money markets less attractive, turning investors away from the pound and towards other investments.

What do analysts and traders say?

Analysts expect that the upcoming Bank of England meeting on 4th February will garner a lot of attention, and as we get closer to it there will be growing speculation on the possibility of an interest rate cut.  

The pandemic has not helped either, as many economists believe that it has dampened sentiment towards Sterling and resulted in concerns about a slower economic recovery and a more cautious Bank of England. At the same time, other analysts disagree and do not expect an interest rate cut this February. Robert Wood, UK Economist at Bank of America said: "We do not expect the BoE to cut Bank Rate in February. Banks do not seem ready and some rate setters argue negative rates could be counterproductive when GDP is falling.” If this happens then the pound may rise.

With the pandemic and ongoing vaccinations, it is not yet clear how the UK economy will fair. Nonetheless, the UK government is committed to delivering CovidD-19 vaccines to the most vulnerable categories by mid-February. If everything goes as planned, and people are successfully vaccinated, then the BoE might reassess its plans and reconsider whether cutting interest rates is the best possible solution. If the economy shows signs of recovery, then the pound will respond favourably.

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Sterling climbed against the dollar on Monday after the EU and UK announced that they will “go the extra mile” and continue with Brexit negotiations. 

After last week, when the pound fell due to concerns over a no-deal Brexit, this week the pound rose reversing some of its losses. The Prime Minister Boris Johnson and European Commission president Ursula von der Leyen agreed during a “constructive” call on Sunday to “go the extra mile” in order to secure a trade deal for the UK. With no deadline for negotiations, British officials have said that negotiations could continue until Christmas. 

What do analysts say?

Whatever happens to the pound is going to have an impact on Thursday’s Bank of England meeting which is expected to remain on hold. Analysts believe that if markets are worried and the pound falls on the prospect of a no deal, then the BoE might increase its QE purchases within a short period of time. Nonetheless, pound volatility as we near the end of 2020 is to be expected. 

Goldman Sachs has predicted that the pound will rise if there is progress towards a deal or a no-deal Brexit is avoided. Barclays analysts explained that there will be risks to the pound until an agreement is reached. As the Financial Times reported, some analysts have changed their mind, quoting Gregory Perdon, co-chief investment officer at Arbuthnot Latham, who had “second thoughts” about the pound rising, but he reiterated his hopes for a deal as  “both parties are probably better off economically with a deal.” “Let’s hope rationality wins in this instance,” he added. 

Others more pessimistic, have warned that the pound’s gains might be short-lived, as both the UK and EU have failed to reach a deal repeatedly in the past.

Talking to Reuters, Junichi Ishikawa, senior foreign exchange strategist at IG Securities said: “This is a temporary move higher in the pound, but it is still not clear that a no-deal scenario can be avoided.”

Whether there is a deal or no deal, some investors feel that the pound could still move sharply.

What’s next?

The UK left the European Union on 31 January 2020, but the ongoing negotiations between the UK and EU officials are focussing on securing and negotiating a deal about the rules that will determine and define the kind of relationship the two parties will have post-Brexit. Michel Barnier has commented that Boris Johnson has made a mistake for hoping to negotiate an agreement within only 11 months.

The two sides have until 31 December 2020 to agree a trade deal and, if there is a deal, border checks and taxes will be introduced. The transition period ends on 31 December, and tariffs and quotas will be introduced in the event of a no deal.

A joint UK-EU statement stated that “despite the fact that deadlines have been missed over and over we think it is responsible at this point to go the extra mile."

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The pound was pulled from different directions yesterday, as on the one hand, the Bank of England hinting at negative interest rates pushed it lower, and on the other hand, positive Brexit news helped lift it.

The pound fell after the Bank of England said that it is considering how to use negative interest rates and it will discuss with regulators how to efficiently implement them. The pound dropped sharply after the announcement.

As quoted on Bloomberg, Valentin Marinov, head of foreign exchange research and strategy at Credit Agricole SA, said: “Negative rates are the nuclear option. It could ultimately push the pound into uncharted territory of losing whatever is left of its rate advantage.”

A Brexit Trade Deal is Still Possible

Despite the negative news, there was a glimpse of positivity on Thursday after the EU Commission President Ursula von der Leyen said that she remains "convinced" that an EU-UK trade deal is still possible, which helped the pound recover. Von der Leyen, speaking to the Financial Times, said: "I am still convinced it can be done. It is better not to have this distraction questioning an existing international agreement that we have, but to focus on getting this deal done, this agreement done - and time is short." Another EU diplomat said that "we should not overreact... We will continue negotiations because there are two separate tracks: one is the one which the UK has decided to violate, and the other is the future relationship."

If markets maintain a similar view that a trade deal is possible then the pound will be supported.

Bank of England’s Negative Interest Rate Surprise

After the Bank unexpectedly said that it was considering the possibility to cut interest rates to 0% or below in the coming months, to help support the economy, the pound fell.  There have never been any negative interest rates before in the UK and if the Bank moves ahead with changing the rates to record lows, this could really shake the financial system, especially due to the UK’s current account deficit. As Pound Sterling Live noted, this could leave “the UK's financial system, and Pound Sterling in particular, exposed to capital withdrawals from foreign investors.”

The shocking revelation was found within the Bank’s minutes to the meeting where it stated that it would start a "structured engagement" with the Prudential Regulation Authority in order to potentially cut interest rates to negative.

Senior market analyst at Western Union, Joe Manimbo said: "The U.K. Pound staged a swoon after the Bank of England dropped clear signals that it was edging closer to implementing negative borrowing rates. The big news was that officials were actively studying plans to push rates below zero given the ‘unusually uncertain’ economic outlook. Central bankers noted better data of late but signalled heightened concern related to Covid uncertainty, expectations of a sharp rise in unemployment and potential Brexit shocks."

However, some economists believe that the Bank will not push interest rates into negative territory and the recent news is part of the Bank’s research into negative interest rates rather than something more solid and definite.

But as Bloomberg said, a no-deal Brexit might just be the trigger for the BoE to use negative rates: “It’s becoming increasingly likely that if the economy is blown off course next year, the central bank could employ sub-zero rates.”

With the UK struggling to contain coronavirus infections, the imposition of new lockdown restrictions, unemployment and a disruptive Brexit could make the situation in the UK very difficult and push the Bank to make some hard decisions.

 

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