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 outlook for Sterling will remain at risk as market analysts are cautious for the UK currency, especially with the new week having started with further pound declines.

Bank of England policy meeting

While the pound has enjoyed gains in the beginning of the new year and until recently, analysts are slowly becoming more cautious following last week’s sharp decline with traders less confident in the currency. Therefore, traders will focus on this week’s Bank of England policy meeting on Thursday for some direction for Sterling. If the Bank of England's Monetary Policy Committee delivers a more hawkish than expected message then the pound could regain some of its recent losses against the US dollar, analysts believe. On Thursday, the Bank of England will provide their latest assessment on the UK economy but is not expected to take any action and it will leave interest rates unchanged. It will be in August’s policy report that any possible major changes in the Bank’s direction will be announced, and the market will focus on such expectations and whether economic recovery will drive the Bank to change interest rates next year. If the Bank reveals any signs that it is going to move towards this direction, then the pound might be lifted by the end of the week.

Potential dangers for the pound

Some analysts believe that much of the positive news is already priced in and that the pound will be vulnerable to downside moves if economic data disappoints. It has also been noted that we should be more optimistic as the pound has responded rather well to economic data, but that currency risks are indeed real and could potentially hurt the pound. For example, there are currency risks related to the futures market as there are traders who are holding long positions—meaning they have purchased Sterling and are waiting for the currency’s price to go up—and when those positions are undone and the pound is sold, they will expose the pound to a fall.

There are also risks regarding the pound’s performance and the loss of momentum. The Sterling 2021 rally has now stopped, and this is a possible reason for concern.

Another possible reason for concern is the rising tensions between the UK and EU and a potential trade war about the Northern Ireland protocol. The EU has threatened the UK with tariffs on UK exports if Britain fails to implement the Northern Ireland protocol. Analysts remain cautious as discussions continue and further potential challenges arise. It was announced last week that the UK government requested from the EU the suspension of some elements regarding the Northern Ireland protocol until October, while they strive to reach an agreement on transporting chilled meat products from Great Britain to Northern Ireland. Any news regarding tensions between the UK and EU on the Northern Ireland protocol could trigger Sterling volatility.

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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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