Higher-than-expected inflation has helped the pound rise against the US dollar, as markets expect the Bank of England to proceed with further interest rate hikes.

According to the Office for National Statistics, UK CPI inflation rose 6.2% year-on-year in February, more than the 5.9% increase markets were expecting and higher than the 5.5% reported in January. Core inflation rose 5.2% in February, more than January's 4.4% figure. As a result, prices for goods rose, including those for food and games.

UK inflation

UK inflation has surged to a new 30-year high as higher energy, fuel bills and food prices drove the worst cost of living squeeze in decades. That’s the highest inflation reading since March 1992, at a time when household budgets are coming under extreme pressure. Last week, the Bank of England predicted inflation could reach 8% in April and could even go as high as 10% in the autumn when the energy price cap rises again.

The news comes hours before Rishi Sunak presents his mini-budget, as he prepares a fresh package of measures to alleviate inflationary pressures on consumers. He is expected to promise “a faster-growing economy, the security of more resilient public finances, and security for working families as we help with the cost of living.”

Sunak has a difficult task, as with inflation so high, taxes rising next month, and benefits such as pensions rising by 3.1 per cent, household incomes will experience a sharp fall.

Jack Leslie, senior economist at the Resolution Foundation has said that the Chancellor will need to set out a bold response to the situation as “Another sharp rise in inflation last month offers a foretaste of the huge income squeeze coming this year, with inflation likely to hit at least 8 per cent this spring – which could be the highest it’s been in 40 years – along with a second spike this autumn.” Leslie noted that prolonged high inflation “is a complete disaster for living standards. It will mean pay packets continuing to shrink, along with vital income support such as Universal Credit and the State Pension. The Chancellor will need to set out a bold response to this cost of living crisis in his Spring Statement today, starting with ensuring that benefits keep pace with inflation over the coming 12 months, rather than shrink by £10 billion as they are currently on course to do.”

Bank of England rate hikes

Markets have raised their expectations this week for the number of Bank of England rate hikes that are likely to be delivered in 2022, pushing the value of the pound higher. If this continues, then the pound will go higher.

Economists are concerned that inflationary pressures will continue to persist and increase, adding more pressure to the Bank to act.

Pantheon Macroeconomics has reported that higher inflation will stall UK economic recovery as households’ spending power shrinks. Chief U.K. Economist at Pantheon Macroeconomics Samuel Tombs expects the BoE to stop raising interest rates once the Bank Rate is 1.00% in May as further rate hikes will increase the risk of economic recession. The market has priced in up to 138 points of rate hikes for 2022 which means there is room for disappointment if the Bank pauses hiking rates which could also push the pound lower.

 

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 has recovered against the euro and US dollar, but some analysts expect it to remain within the same range and not rise or fall remarkably. Markets seem to be a bit more optimistic and expect further Bank of England interest rate hikes. The war in Ukraine continues with little progress being made, and markets are starting to digest the implications of Russia’s aggression in Ukraine.

The pound was one of the worst-performing currencies since the war in Ukraine started and traders have adjusted to this. While some analysts believe the pound will be supported in the near-term, however, if the situation in Ukraine deteriorates, then it could drop.

Uncertainty continues for the pound

  • Ukraine conflict

Market risk appetite has returned modestly, and the pound will continue to benefit as sentiment improves. While the war in Ukraine continues, there is hope that a deal could be reached, as talks between the two sides continue. However, Dmitry Peskov, the Russian Presidential spokesman, said on Monday that the two sides were still far apart. There were also hopes that the two presidents, Ukrainian President Volodymyr Zelensky and Russian President Vladimir Putin would sit and resolve issues, but this looks to be highly unlikely, at the moment.

Analysts have noted that, after the Covid-19 pandemic and Brexit, the Russia-Ukraine conflict is another considerable risk and could stall any upside potential for the pound. The crisis has worsened the outlook for risk currencies such as the pound, with the euro being more vulnerable.

  • Bank of England interest rate hikes

Expectations for further Bank of England interest rate hikes has been a key driver for the pound and continues to lend support to the British currency. The Bank hiked 25 basis points last Thursday, as expected, but the cautious tone of the Bank about the number of rate hikes disappointed markets and pushed the pound lower.

The Bank has warned the market not to expect as many as 120 basis points of rate hikes which were priced in by the market for the rest of the year, as inflationary pressures could impact on economic growth. Some economists feel that it will be much more difficult for Sterling to strengthen following the BoE’s increased focus on inflationary risks to growth.

The pound has recovered recently, however, and the Bank of England remains much more hawkish than other banks, with at least two interest rates expected by most analysts.

Tuesday’s report: UK government borrowing higher than expected

UK government borrowing rose more than expected in February, as higher inflation pushed debt interest payments higher. This is disappointing news for Rishi Sunak the day before he presents his spring statement in the Commons.

The Office for National Statistics said the government’s budget deficit was £13.1bn in February, the second-highest borrowing figure for February since records began in 1993. Higher inflation pushed up interest payments on government debt by more than 50%. The chancellor responded to the higher-than-expected government borrowing by saying:

“The ongoing uncertainty caused by global shocks means it’s more important than ever to take a responsible approach to the public finances. With inflation and interest rates still on the rise, it’s crucial that we don’t allow debt to spiral and burden future generations with further debt. Look at our record, we have supported people - and our fiscal rules mean we have helped households while also investing in the economy for the longer term.”

Economists expect the chancellor to be cautious tomorrow. Samuel Tombs, chief UK economist at Pantheon Macroeconomics said that Rishi Sunak could “announce a limited package of measures, amounting to a net giveaway in 2022/23 of about £13bn, or 0.5% of GDP. That probably would mean that households still will experience this year the biggest annual decline in their real disposable income since the Second World War.”

Wednesday: What to watch

The UK’s CPI numbers on Wednesday are key as the Bank of England (BOE) has raised interest rates by 25 basis points last week. The UK inflation numbers on Wednesday will influence any potential  monetary policy decision the BOE will have to make in its next policy announcement.

The monthly and yearly Producer Prices Index (PPI) Core Output on Wednesday will also be watched, with a preliminary estimate for the monthly PPI Core Output at 0.9%, and an estimate for the yearly PPI Core Output at 10%, higher than the previous 9.3%.

 

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 is under pressure as market mood has weakened following renewed concerns over Russia's invasion of Ukraine. The divergence between the Fed and Bank of England (BoE) policy has also hurt the pound and could continue weighing on the British currency.

The BoE hiked interest rates by 25 bps but showed caution regarding further tightening, dampening the pound outlook. Analysts expect the pound to US dollar exchange rate to remain under pressure if it continues trading at a lower level. The pound to euro exchange rate could also struggle to recover this week following the BoE’s cautious tone last Thursday.  

What to watch out this week

  • Andrew Bailey’s remarks

The key event of the week ahead for the pound will be Governor Andrew Bailey’s participation in a panel discussion this Wednesday titled Emerging Challenges for Central Bank Governors in a Digital World, at the Bank for International Settlements Innovation Summit.

  • Inflation figures

On Wednesday, inflation figures for February will also be closely watched as investors would like to see how soon the Bank could raise interest rates again.

Analysts expect the Monetary Policy Committee (MPC) of the BoE to be less optimistic and more passive in the second half of the year, which could drive the pound lower. It is now expected that the pound will be under pressure especially if inflation is higher than expected, and at a time when the BoE is concerned with the risks to growth.

  • Mini budget

Apart from February’s inflation figures and comments from Andrew Bailey, on Wednesday we also get HM Treasury’s announcement of its latest budget update, which will also be analysed by market participants. Chancellor Rishi Sunak is under pressure to announce further financial measures to support households who are suffering from the worst cost of living crisis for at least 20 years.

While the UK was getting ready for the biggest squeeze on living standards, the war in Ukraine has deepened the crisis. The surge in the price of oil has pushed petrol and diesel prices higher. Economists warn that further pressure on food and energy prices could push inflation even higher. With domestic energy prices and taxes already rising in April and continued volatility in commodity markets, the Chancellor of the Exchequer is facing even more pressure to alleviate the pain when he reveals the springtime mini-budget on Wednesday.

Now, the problem is not only the poorest households, as due to higher and persistent inflation families who needn’t worry about the cost of living are now also facing difficulties. The chancellor is expected to extend his earlier £9bn package of support for energy bills, which has been reduced by higher inflation. However, speaking to the Conservative conference in Blackpool, he avoided clarifying how he might help households with bills and admitted that global inflationary pressures and higher prices were out of his control. The chancellor said he had “enormous sympathy for what people are going through”, but “I can’t solve every problem. No government can solve every problem, particularly when you’re grappling with global inflationary forces. They are somewhat out of my control.”

Markets will await to see how Sunak will make a difference in his statement on Wednesday, whose popularity rankings have grown during the pandemic following a huge economic support package. As he said on Sunday, “I will stand by [the people] in the same way that I have done over the past couple of years. Where we can make a difference, of course we will.”

The pound fell on Wednesday despite the UK budget statement, which was in line with expectations. There was no indication that Chancellor of the Exchequer Rishi Sunak’s budget announcement contributed to the market movement. The fall is possibly linked to a drop in the yield of long-duration UK government bonds and shows that markets expect the government to reduce borrowing in the coming years.

2021 Budget

In general, news about today’s budget statement was positive about the economic outlook, regardless of the fact that there was no fiscal stimulus announced. Sunak, said he had asked the Bank of England to remain committed to controlling inflation and keeping it low and stable, as anything above 2.0% will not be favourable in the long term. Next Thursday, with the Bank of England meeting, pound volatility will be expected.  

Rishi Sunak said that his budget delivers a stronger economy, stronger growth, public finances and employment, so that it is possible to begin building the economy post-pandemic. As he noted: “Let there be no doubt: our plan is working.”

Growth

Sunak said overall spending will increase by £150 billion, the "largest increase in a century", as the economy is expected to grow and expand 6% in 2022. The chancellor said that forecasts from the Office for Budget Responsibility (OBR) show the economy will grow by 6.5% this year, 6% next year, 2.1% in 2023, 1.3% in 2024, and 1.6% in 2025. Unemployment is forecast to reach 5.2%, down from a forecast of 12% last year.

Inflation

The chancellor said inflationary pressures are currently impacting on the UK economy and the government will make sure to support households. The Office for Budget Responsibility (OBR) is expecting inflation to be around 4% next year.

Borrowing

Sunak said that will set new “fiscal rules” for public finances. During “normal times” the state should only borrow to invest in growth while balancing everyday spending. In the current financial year 2021-22, borrowing will be 7.9% of GDP, and will fall to 3.3% in 2022.

Employment and skills

The chancellor said the government will raise government spending on skills and training by £3.8bn. The government will create a UK-wide numeracy service called Multiply to help 500,000 adults. This is part of the government’s commitment to improving lifelong learning and productivity. While a lot of this has already been announced, the 43% increase in spending is considerable.

Business taxes

The bank surcharge will be cut from 8% to 3%. Business rates will be changed to help companies and a new 12-month relief will be provided to companies to invest in their premises. The incentives are worth £750m. Sunak said that 2022’s intended increase in the business rates multiplier will be terminated. There will also be a 50% business rate discount for companies in retail, hospitality and leisure. The cut is worth £1.7bn. The chancellor highlighted that “This is the biggest single year tax cut to business rates in over 30 years.”

Taxation and universal credit

Sunak also announced that the taper rate in universal credit will be cut from 63p to 55p. This will be worth more than £2bn. The work allowance will be increased by £500.  In regards to taxes, Sunak confirmed: “By the end of this parliament I want taxes to be going down, not up.”

The reforms to the universal credit system will enable only those in work to keep more of what they own and will encourage employment.

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The pound rose on Tuesday against both the euro and the US dollar, as stock markets increased, and expectations for an early November rate hike by the Bank of England remained strong. This is the highest level since the pandemic started in March 2020. If the Bank of England proceeds to an early rate hike, then markets will not be disappointed and the pound will rise further, as many analysts suggested. However, if it strikes a more cautious tone and reduces expectations for further rate hikes in 2022, then the pound could fall.

A hawkish statement by the Bank of England suggesting a faster cycle of hikes than is currently expected might boost the pound further, but this is not anticipated.

Interest rates

If the Bank of England raises interest rates as soon as the 4th of November, then the UK central bank will be the first major central bank to raise rates ahead even of the European Central Bank (ECB). The pound rose against the dollar, but the gains were not substantial as the US Federal Reserve is on target to raise interest rates in 2022 with the November policy meeting likely to confirm this.

The lower number of Covid-19 cases has helped boost market sentiment and has given the Bank of England further evidence that the economy has the potential to grow as we come to the end of the year.

Current and potential obstacles

However, Britain's weak economic data, such as Friday's unexpected drop in retail sales has capped further gains. UK growth momentum is also weakening. There are also concerns about potential tax hikes that could be announced on Wednesday's budget statement, alongside tensions between the EU and the UK post-Brexit provisions relating to the trade between Britain, Northern Ireland, and the European Union member Ireland.

A possible headwind for the pound is the failure of the negotiations between the two sides over the Northern Ireland protocol, as Britain has threatened to take unilateral action if talks fail. #

Rishi Sunak’s budget announcement on Wednesday

Traders are now awaiting finance minister Rishi Sunak's budget statement on Wednesday. Markets might be already aware of his plans for higher corporation tax and national insurance contributions, but the devil is in the details. He is expected to end the public sector pay freeze for millions of workers and there has been speculation that the minimum wage for those aged 25-plus could increase from £8.91 an hour to £10 before the next election. For the NHS, there have also been announcements for a £5.9bn for NHS backlogs, diagnostic services and elective surgeries funding, while a £2.1bn is going to improve IT across the NHS. Another commitment has been for £5bn on health research and development over three years. A total of £850m has been promised to inject new life into the arts as a “post-pandemic funding boost.” £700m has been promised to be spent on the new post-Brexit borders and immigration system, and a new maritime patrol fleet. Among his other pledges, is a six-month extension to the COVID recovery loan scheme to June 2022.

If you are a business transferring funds overseas, contacting a currency specialist could save you time and money. Get in touch with Universal Partners FX and their dedicated team to discuss the latest market movements ahead of your currency exchange. If you are transferring funds to pay your employees abroad, get in touch with Universal Partners FX to find out how much you can save in your international money transfers. Universal Partners FX can provide invaluable help on efficient risk management and tailored solutions to your business’ transfer needs.

Pound Falls after Weak UK Data

Sterling has fallen after the release of weak UK data, and is trading lower against both the dollar and the euro. The fall comes after yesterday’s gains when the pound reached the highest level since spring 2008.

UK retail sales in 2020 post record fall

Despite expectations for a 1.2% gain, retail sales volumes in the UK rose by just 0.3% in December from January, according to data from the Office for National Statistics released on Friday. Clothing sales rose 21.5% after a 19.6% drop in November. In 2020, retail sales fell by 1.9% when compared with 2019, due to the coronavirus lockdowns. On the other hand, online and mail order sales rose 32% in 2020. Clothing stores, petrol stations and department stores recorded significant falls in sales volumes when compared to 2019.

Jonathan Athow, deputy national statistician for Economic Statistics, said: “December’s retail sales increased slightly, driven by an improved month for clothing sales, as the easing of some lockdown measures for parts of the month meant more stores were able to open. Food store sales this month were subdued as retailers reported lockdowns and restrictions on the sale of non-essential items impacted on footfall. Retail sales for 2020 saw their largest annual fall in history as the impact of the pandemic took its toll. Clothing retailers fared particularly badly, with a record annual fall of over 25%, while movement restrictions led to a record year-on-year decline for fuel sales.”

Ian Geddes, head of retail at Deloitte, noted that retail showed resilience as “Strong performance in grocery and record-breaking online sales for non-food meant that Christmas 2020 was the most digital ever.” He also added: “For now, pent-up demand is likely to see shoppers out in force once restrictions lift, as we saw in summer at the end of the first lockdown. Crucially, the reopening of the high street will this time coincide with the ongoing vaccine rollout, which should boost consumer confidence and see them return to stores once more.”

Paul Dales, chief UK economist at Capital Economics, also commented: “The tiny rise in retail sales in December shows that it wasn’t a very merry Christmas for retailers. And January’s lockdown means it won’t have been a happy start to the new year either. But at least retailers are more immune to lockdowns than many other consumer-facing businesses. The upshot is that retail sales added almost nothing to GDP in December and January’s lockdown means sales will probably drop back again this month. Admittedly, they won’t fall as far as non-retail consumer spending. According to daily data of electronic card payments, so far this month consumption has declined from being slightly above its pre-pandemic level in December to about 35% below. We suspect that GDP may fall by around 2% m/m in January. But hopefully that will be the last decline.”

Government Borrowing

The release of separate data showed that the UK’s borrowing rose in December to the highest level and it marked the third-highest borrowing in any month since 1993 when records started. The ONS said that public sector net borrowing was £34.1bn in December 2020, £28.2bn more than in December 2019.

Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said that it is possible that total borrowing could be close to the OBR’s £393.5bn forecast. He explained that December’s high borrowing “reflected a 26.1% year-over-year jump in central government expenditure, mostly related to the Coronavirus Job Retention Scheme and the Self-Employment Income Support Scheme. Tax receipts were only down 1.2% year-over-year, thanks to growth in corporation taxes and stability in income tax receipts. However, borrowing will fall once the support schemes expire at the end of April –– and next year we could see sharp tax rises, to get the public finances back on track, Tombs predicts. Public borrowing will fall sharply from about 20% of GDP this year to between 8% and 10% in 2021/22, if the government stops the furlough and self-employment income support schemes in the spring, and healthcare spending declines. We doubt that the Chancellor will go a step further in the Budget on March 3 and push through large immediate tax rises or non-health spending cuts.” He noted that fiscal policy will tighten, and taxes are expected to rise significantly in 2022.

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