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

The pound was lower against the US dollar amid a cautious market mood. The latest peace talks between Russia and Ukraine have failed, and the two sides have not yet reached a ceasefire agreement. The war and US inflation fears will boost the US dollar's haven demand. The pound is stronger against the euro, but if sentiment declines further then both currencies will lose value against the dollar. However, analysts believe the pound could rise against the euro. With uncertainty and the possibility of a breakthrough in the negotiations looking highly unlikely, the foreign exchange market will remain volatile.

Russia – Ukraine talks

No progress has been made after a meeting on Thursday between Ukrainian Foreign Minister Dmytro Kuleba and Russian Foreign Minister Sergei Lavrov in Turkey's Antalya. Ukraine’s foreign minister said he discussed a 24-hour ceasefire with his Russian counterpart who defended the invasion and said it was going as planned. The meeting is the first high-level contact between the two sides since Moscow invaded Ukraine at the end of February. While officials from Kyiv and Moscow have met previously, this is the first time Russia sent a minister for discussions.

Lavrov said Russia wants to continue the negotiations with Ukraine and underlined that Russia would not have started the war if the West approved “our proposal on security guarantees.” He added: “Until the end, we wanted to resolve the situation in Ukraine through diplomatic means.”

Market optimism could be hurt from the risk of a further escalation in tensions between Russia and the West, while investors are concerned about inflationary pressures’ impact on the global economic outlook. This will limit any potential gains for the pound against the US dollar, and with little economic releases from the UK, the British currency will be driven by US dollar dynamics. 

Euro

The euro held most of its gains from yesterday as investors await the latest ECB policy decision for  fresh stimulus. The war in Ukraine might not push the ECB to change its hawkish stance especially when inflation is so high. The risk of a further escalation of tensions between Russia and the West could push the euro lower.

Bank of England

Uncertainty from the invasion of Ukraine will limit the number of rate hikes by the Bank of England (BoE) despite concerns for embedded inflation. Economists at Westpac note that the GBP/USD pair is at risk of suffering a sharp decline. Concerns about the cost of living will limit any upside potential for the pound and further rate rises. They said: “BoE had cited the cost-of-living pressures as a reason for a more gradual tightening path, but they will also be unable to ignore surging inflation. The net outcome is likely to be a lower and slower path of withdrawing accommodation.”

Global Inflation concerns

Markets remain concerned with rising inflation and commodity prices which could lead to a global recession. A global growth slowdown will support the safe-haven US dollar.

The euro however found support from the prospect of EU member states issuing a joint bond to finance increased defence spending and ease the impact of the energy crisis. The European Council will meet today in Versailles, France and more details might become clear. Analysts noted that such plans could end up being steeped in bureaucracy.

If the war in Ukraine continues, the euro will be lower against commodity and safe-haven currencies. Volatility will continue in the currency markets, while the exclusion of Russian commodity exports from global markets will increase inflation and require the establishment of new supply chains and routes.

The pound rose against the US dollar, and the euro strengthened as global market sentiment has improved. With improved global investor mood and news that European countries could issue a joint bond to finance new defence spending and the area’s energy crisis, the euro rose. Stock markets rallied following the positive market sentiment.  

Reports suggesting that Ukraine won’t insist on NATO membership has also boosted hopes of a de-escalation of the crisis ahead of Thursday's meeting between Russian Foreign Minister Sergei Lavrov and his Ukrainian counterpart Dmytro Kuleba.

For the moment, risk sentiment is the main market driver, and the pound could extend its recovery if the situation improves.

Russia has agreed to a new 12-hour ceasefire to allow civilians to flee some of the most affected areas in Ukraine, according to Ukraine's Deputy PM Iryna Vereshchuk.

Bank of England

On Tuesday, the British government announced that it will slowly reduce its imports of Russian oil and oil products by the end of this year. Economic activity will be hurt by the rising oil prices, Bank of England (BOE) Monetary Policy Committee Member Silvana Tenreyro said at a discussion hosted by Britain's Economic Research Council. She added that there was no immediate evidence of a wage-price spiral in the UK. She explained that policymakers would begin to review economic activity at March's Monetary Policy Committee meeting and when the BoE next updates its forecasts in May. She noted: "Recent developments will intensify the terms of trade shock that we were already experiencing, so will push up inflation and have a negative impact on activity. How exactly? That's the job we will start next week.”

Financial markets still expect the BoE to raise rates from 0.5% to 0.75% on the 17th of March, and as high as 1.5% by August in order to control surging inflation from becoming rooted.

She clarified that if the UK's action on Russian oil imports weighs on growth, then the BOE could avoid tightening monetary policy, but such a move could hurt the pound.

Euro

The euro rose on Wednesday due to improved sentiment and news that the EU Commission will announce plans of EU countries jointly issuing bonds to finance energy and defence spending. The move is seen as supportive of the common currency. The prospect of joint bond issuance has boost sentiment and helped to push the euro higher.

The plan for the jointly issued debt will be announced at Thursday's meeting of the European Council where leaders will meet to discuss the ongoing war in Ukraine. Bloomberg reported that the EU Commission could issue bonds and then send the funds to member states in the form of concessionary loans to finance spending in those countries.

The euro dropped against the dollar, pound and other major currencies since the war in Ukraine began due to diminished expectations about the Eurozone’s economic growth. The euro and European currencies have been hurt by the war and could drop even further if the situation worsens. Markets will remain highly sensitive to news and developments relating to the war in Ukraine. The pound will remain under pressure against the US dollar but supported against the euro if the conflict continues.

Sterling could record new gains against the US dollar in the coming weeks as more economic releases support expectations for Bank of England (BoE) tightening.

FX Strategists at UOB Group, have noted that the pound rose more than expected yesterday and this upward momentum could continue unless the British currency falls within the next couple of days.

However, the persistent Russia-Ukraine tensions will continue to impact on both the pound to euro and the pound to US dollar exchange rates.

GBP/EUR and GBP/USD: Ukraine-Russia tensions

The pound could maintain an upward trend against the euro, but analysts believe that the euro will prevail. The main driver for the pound to euro exchange rate is the Ukraine-Russian situation. The last week, we have witnessed the pound rising and falling, before recovering as news on the geopolitical tensions created volatility.  On Wednesday, optimism returned to markets but soon faded as it was made clear that nothing has changed and that over 120K Russian troops were still stationed on Ukraine's borders with little progress having been made.

This is why the pound to euro exchange rate will move according to news and speculation relating to the Ukraine-Russia issue.

The uncertainty about the Russia-Ukraine conflict will also put the pound to US dollar exchange rate at risk. Reports claiming that Ukraine has bombed separatists' positions in east Ukraine caused safe-haven flows to dominate the markets. Ukraine denied these claims and the Ukrainian military reported that Russian occupying forces fired on a village in the Luhansk region. A senior White House official said that Russia’s claim that is moving troops away from Ukraine’s border is false. He also warned that Russia could launch a false pretext to invade Ukraine at any moment. These developments have soured market mood as investors remain on edge.

A further escalation of geopolitical tensions could weigh on GBP/USD while a positive shift in risk sentiment will boost the pound.

European Central Bank

The turn in the European Central Bank’s policy which was announced on their 3rd of February update has supported the euro. The ECB said that due to inflationary pressures they would no longer be against a rate hike in 2022, which has led the market to price in a number of 10 point hikes to the Deposit Rate, that would take it back to 0% by the end of 2022. For the GBP/EUR currency exchange rate, what will determine its performance will be the timing of monetary policy tightening in relation to that of the Bank of England.

Foreign exchange strategists at HSBC believe that the euro will rise against the pound as they see  the Bank of England disappointing market expectations. They said: "We think there appears to be room for the Bank of England to disappoint relative to market pricing, which has more than a 50% chance of a 50bp hike.”

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The pound rose against the US dollar following strong UK labour-market numbers. British employers added a record 241,000 staff in August, pushing the total number of employees on company payrolls above pre-pandemic levels, official data showed on Tuesday.

The latest unemployment report by the Office for National Statistics shows job vacancies rose above one million for the first time since records began as the UK economy continues to recover from the Covid-19 pandemic, while payrolls rose by more than expected. The strong data will possibly help persuade Bank of England policymakers that perhaps UK monetary policy could be tightened sooner than expected.

Jobs data

The latest unemployment report showed the number of vacancies in the three months to August to have reached above one million, as firms struggled to fill positions mainly in the hospitality, transport and storage sectors. It also showed a lower unemployment rate and a monthly increase in August payrolls.

The ONS stated: “The fastest rate of growth was seen in other service activities, which grew by 93.3% (12,500), followed by transport and storage at 76.3% (20,300) and accommodation and food service activities at 75.4% (57,600). In the latter two categories labour demand has increased rapidly while staff availability fell because of a mix of employees leaving these sectors to find employment elsewhere and a reluctance of workers to return to their previous roles.”

Minister for Employment Mims Davies MP has welcomed the rise in payrolls and said: “As we continue to push ahead with our recovery, it’s great to see another significant fall in unemployment and the number of people on payrolls rising by 241,000 in August – the biggest monthly increase on record – showing our Plan for Jobs is working. We’re helping employers recruit for the record number of vacancies out there, particularly in growing sectors, and supporting people of all ages and backgrounds to overcome barriers, land their next role, and progress in work.”

While payroll employment is back at pre-pandemic levels, there are still many years ahead of recovery, with employment more than 700,000 down and long-term unemployment up 45%. There are still more than a million people furloughed and with the scheme ending this month, more people will be looking to find employment.  

Furlough scheme concerns

Economists and politicians are worried that with the furlough scheme ending this month, jobs recovery will be hurt, after the rise in payrolls and vacancies. A lot of furloughed staff might not even return to their jobs as a lot have had their wages subsidised and might not be kept into full-time employment.

There is also a skill shortage as many industries have reported a lack of available labour and hiring difficulties. With Covid adding more uncertainty after Brexit and the new national insurance tax adding more costs to employers, it is unclear how businesses will respond to future hiring needs.

While the data is positive for the pound, investors remain cautious ahead of Wednesday’s UK inflation data, which could show an increase in the core rate in August to 2.9% year/year from July’s 1.8%.

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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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The British currency rose against the US dollar and the euro, after the return of investor confidence.  With the recovery of major stock markets, investor risk appetite returned helping boost currencies such as the pound which are closely influenced by global market sentiment. The pound is considered a risk currency and is vulnerable to risk-off sentiment at times of risk-on.

Major concerns such as the Delta variant and the Fed’s removal of its stimulus programme will be the main drivers for global currencies such as Sterling. While there is still significant uncertainty about how the delta variant will affect markets, most developed economies are expected to grow steadily. Nonetheless, Sterling will remain sensitive to global developments than domestic economic data, as the economic calendar is thin with releases of little impact.

Risk on and Risk off sentiment

The widespread risk on and risk off sentiment, also known as RORO is the major driver of currencies in the market at the moment. Two of the key concerns of global investors are the withdrawal of the Federal Reserve’s stimulus and the rapid spread of the Delta variant in Asia.

But what is exactly risk sentiment? Simply, risk-on risk-off refers to shifts in investment activity as a result of global economic events. The foreign exchange market is basically affected by changes in the ways investors behave and where they choose to invest. The theory states that investors engage in higher risk trades when the risk is considered low and avoid high-risk investments when the risk is perceived to be high. So, investor appetite changes depending on global sentiment and whether risk is high or low. For example, the 2008 financial crisis was considered a risk-off year, as investors avoided risk by selling their risky assets and turning towards low or no risk positions such as U.S. Treasury bonds.

The risk-on risk-off sentiment is also affected by different asset classes, as some carry higher risks. Stocks are riskier than bonds and so when stocks are preferred more than bonds then the market is considered a risk-on environment. A risk-on environment is one where investors invest into riskier assets.

A risk-on environment is usually one where a combination of positive economic factors, data and events co-exists, showing that the market is healthy and strong, and risk is limited. Strong economic data such as corporate earnings, an optimistic outlook, and supportive central bank policies reflect a market where investors have more room to take on more risk.

Federal Reserve and monetary stimulus

In the coming week, the fundamental concern for markets will be the Federal Reserve's decision to withdraw monetary stimulus. On Thursday, Federal Reserve Chair Jerome Powell will give a speech at the Jackson Hole central banking symposium and investors expect him to announce the Fed is ready to start reducing stimulus, possibly as soon as this September. While this is good news for the  US dollar, stock markets which have been supported by the Fed’s funding will find the news disappointing. This will also affect the British pound which could fall following such an announcement. For some analysts, Powell might avoid bringing up monetary policy at the symposium, but others believe that the dollar will weaken if the Fed postpones the planned withdrawal of its funding.

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Sterling experienced some volatility after reaching a fresh three-year high against the US dollar due to expectations for an economic recovery and positive house price data. Some analysts have attributed the surge in the pound to positive global investor sentiment about the UK economic recovery, while others pinned the pound’s gains on a retreat in the US dollar.

US dollar weakness & BoE interest rates

According to strategists at Toronto-Dominion Bank, “The whole ‘U.K. vaccine’ story is a little tired.” It’s probably less about the U.K. and more about the USD, which has been drifting lower overall.”

Beyond the prospect of unlocking the economy, the pound found support from expectations that the Bank of England will soon signal that it may start to raise interest rates next year. The UK’s economic recovery and the potential of the Bank of England ending asset purchases and hiking are encouraging traders to buy the pound.

Concerns about the new variant

However, Sterling has also been influenced by concerns over a new coronavirus strain which pushed the currency lower. The new Indian variant along with concerns about reopening the economy on 21st of June have dented some of the pound’s recent gains. The new strain appears to be more transmissible than previous ones. While the variant did not appear initially to pose a big threat, growing concerns from the government as to whether the UK will fully reopen the economy or there will be delays, have hurt the pound.

The Indian variant is spreading across the UK and the latest statistics suggest Covid-19 cases are starting to rise sharply. The strain is mostly found in England. The government is waiting for more data before it decides to relax restrictions. Politics will also play a role, especially after the criticism the government has faced regarding its handling of the pandemic. Boris Johnson’s government is under political pressure following testimony to MPs by Prime Minister Boris Johnson's former senior adviser Dominic Cummings. This might drive the government to adopt a more cautious approach to June 21.

Any delay will be seen by traders and markets as negative for the pound in the short-term as it could hurt business and consumer confidence while postponing the ability of the economy to recover fully. The fact that such concerns about the economy have also coincided with increasing public scrutiny of the government’s response to the Covid-19 pandemic, they could potentially drive the pound lower against both the US dollar and the euro.  

For this week then, the main drivers for the pound will be any signs showing that the government intends to fully lift Covid-19 restrictions on 21 June and any data regarding the impact of the Covid-19 “Indian variant”.

 

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The pound has potential to rise further as more positive news is expected, while some risks remain relating to concerns about the pandemic and a rising euro. The latest Lloyds business barometer for the month of May rose to a three-year high, while Gertjan Vlieghe, an outgoing Monetary Policy Committee member at the Bank of England (BoE), said on Thursday that interest rates could rise by the middle of next year. At the same time, with a thin economic calendar the pound could fluctuate unpredictably in what is expected to be a volatile week ahead. also mean that the pound

Rising Renmbibi exchange rates

The Pound-to-Euro exchange rate could be volatile with the potential to rise higher if the recent boost in Renminbi exchange rates leads the Peoples’ Bank of China (PBoC) to buy non-Dollar currencies in a bid to ward off dollar appreciation pressures. China’s exchange rates rose after a decision to allow USD/CNH to fall. The move was the result of concerns regarding rising Dollar-denominated commodity prices and was driven by an attempt to offset the increase through a stronger exchange rate. This eventually resulted in the rise of other Chinese exchange rates that are a macroeconomic hazard for the PBoC, as research analysts have noted. The fall of the USD/CNH supported the Renminbi against all China Foreign Exchange Trade System (CFETS) currencies.

The rise of Renminbi is problematic for the PBoC because it results in cheaper imported goods and could drive the bank to buy other currencies in an attempt to reduce its other exchange rates. In general, a prolonged period of RMB appreciation and USD weakness could become an issue for policymakers and the PBoC could use further administrative tools to control this.

The currency pair could also be further affected by the BoE Governor Andrew Bailey’s speech on Tuesday on the subject of "Building a Finance System Fit for a Clean, Resilient and Just Future."

Euro appreciation could drive pound lower

Analysts have explained that the euro could be the main currency in Europe to benefit from the PBoC’s potential attempt to manage extreme currency appreciation. The pound-to-euro exchange rate has performed well, However, if the euro rises, this will potentially push the pound to euro rate lower. On Wednesday, when the ECB releases a report on the international role of the euro, the common currency could rise, and this could possibly push the pound lower.

Covid-19

At the moment, the markets might be relatively calm in both the US and the UK, and after Friday's volatile trading, but fears of Covid-19 variants may send sterling down, some analysts are saying. FXStreet’s analyst Yohay Elam stated that “People residing in the UK may enjoy the long weekend at home and in several European countries – but not in France nor Germany, where they are required to quarantine. These restrictions serve as a reminder of the B.1.167.2 variant. Sterling is on the back foot due to these fears.”

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Sterling has fallen against the euro and the US dollar, despite the lack of any clear data that could be responsible for the declines. This is also what makes it difficult to pinpoint what news or events could potentially affect the pound’s performance.  

Analysts have argued that since the UK is no longer at the centre of financial news and data, and as interest has shifted to other currencies such as the euro, the British currency has lost momentum. It has also been noted that markets have priced in all the good news for the pound, so no bigger rises are expected at the moment. The successful vaccination programme and the reopening of the economy has provided support to the pound and the market Many analysts have also said that the weakness in the US dollar has also been partly responsible for some of the recent gains, which also highlights the fact that they are not any clear drivers that will push the pound higher. UK economic data has generally surpassed expectations, but this has not necessarily translated to any obvious additional upward pressure.

Higher Interest rates and Pound

Market expectations for higher interest rates, could also provide support to the pound. But for the market to become confident and positive, the Bank of England will need to show signs that is committed to raising interest rates. However, policymakers have not shown any firm conviction of raising interest rates any time soon. While inflation might be rising, BoE Governor Andrew Bailey believes that inflationary pressures are only temporary. But unless the Bank’s Monetary Policy Committee agrees in its majority that it’s time to raise interest rates, the pound is unlikely to rise unexpectedly. At the moment, the pound will be influenced by global market movements.

Cummings’ Testimony, the Pandemic and Indian variant

Sterling has been the second best performing G10 currency against the US dollar this year, because of investors being positive about the UK economy reopening, following its successful vaccination program. Britain started the third phase of reopening the economy last week, allowing indoor dining in pubs and restaurants. Retail sales data were upbeat as well as surveys of purchasing managers across different industries.

This week’s pound weakness has been partly explained by the lack of data, but also by pandemic concerns and Dominic Cummings’ testimony. Cummings’ testimony on Wednesday has been described as the “Sword of Damocles" and his explosive statements have undermined the government and could potentially keep the pound lower. He has likened the management of government officials during the crisis to "lions" being "led by donkeys". The pound may also be subject to news about the pandemic and the worrying rise of cases. The spread of the Indian variant has also added to pound pressure and these factors have partly kept the pound low, despite dollar weakness.

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The pound has risen to its highest level against the US dollar in almost three months. With the dollar weakening, Sterling rose to its highest level since 24th February, supported by jobs data that showed a drop in the UK unemployment rate, to 4.8%, and increase in employment. The stronger than expected jobs report and the weaker dollar help boost the pound.

UK Employment Rises

Employment data from the UK showed a rise in employment with 84,000 gaining jobs in April following the reopening of the economy and the loosening of lockdown measures. The labour market is characterised by high-skilled workers furloughed or made redundant pandemic or low-skilled workers unable to gain new employment. Employers began hiring again in March, which helped to reduce unemployment for a third consecutive month. The number of workers seeking employment fell to 1.6 million in the three months to March, compared with 1.7 million in the three months to February, the Office for National Statistics said. The quarterly rate was down to 4.8% from 4.9% in February.

The number of employees on company payrolls continued to rise but remained 772,000 below pre-pandemic levels. The number of job vacancies also continued to rise into April, with most industries showing signs of growth.

Jobless rate to Rise in Autumn

However, ING expect the jobless rate to rise at around 6% in the autumn, as the furlough scheme comes to an end September. James Smith from ING stated: “We can already see signs of a rapid turnaround in the hospitality sector over recent weeks, where online job adverts have returned quickly to pre-virus levels since the reopening road-map was announced.

While this is a ‘flow’ measure and clearly isn’t the same as saying employment has returned to where it was before the pandemic, it does suggest some of the past employment losses we’ve seen over recent months could be quickly reversed over coming months.”

Thomas Pugh of Capital Economics also said that the unemployment rate may rise to around 6.0% by the start of 2022 but should fall eventually: “The unemployment rate may still rise over the rest of this year. But this will probably be due to people re-joining the labour market rather than more people losing their jobs. Of course, this is all dependent on the path of the pandemic, and whether the UK is able to exit the crisis - or if new variants force new restrictions to be imposed.”

Employment Data is welcome news

The jobs data was welcomed by the Minister for Employment Mims Davies MP who said that the report shows how resilient the jobs market has been. He said: “A continued fall in unemployment, a further rise in vacancies, and growth in the employment rate is welcome news as we continue on our roadmap to recovery. While there is more to do to make sure we support jobseekers over the coming months, these figures highlight the resilience of our jobs market and ability for employers to adapt – and through our Plan for Jobs we’re continuing to create new opportunities for people right across the country.”

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