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

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

Market sentiment: Factors to consider

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

  • Federal Reserve

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

  • Fears of slowing economic growth

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

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

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Traders have warned of pound volatility if Scotland backs an independence bid. It is expected that the pound will suffer in the coming months if Nicola Sturgeon wins a landslide majority in next month's Holyrood election. Unless there is certainty that there will not be a second independence referendum, the British pound will be potentially under threat.

On 6th of May, Scotland will vote for the next Holyrood parliament and if there is strong result for pro-independence parties then more pressure will be placed on the UK government to grant Scotland the right for another independence referendum. SNP leader Nicola Sturgeon has already vowed to push for a second referendum and her demand will be strengthened if pro-independence parties win more than 50 percent of the vote.

While the pound has risen since a trade agreement was sealed with the EU, the ensuing political uncertainty following the May elections could mean that risk-averse investors will stay away from buying UK assets. Polls show the pro-referendum SNP party could win the vote, but, recently, there have been strong concerns about the party’s ability to secure a majority.

What currency analysts are saying?

A heavily pro-independence vote in next month’s Scottish Parliament election could mean a fall in Sterling as investors will avoid trading British stocks. Stephen Gallo, European head of currency strategy BMO Capital Markets, said: “Come early May the markets will wake up to this and probably trade the size of the majority or the end result. The stronger Nicola Sturgeon’s position is, the more headline risk there’s going to be over the next three to six months regarding this issue.” He also said that currency movement won’t be huge but a strong SNP will mean that Sterling will find it difficult to extend its rally. Goldman Sachs’ strategist, Sharon Bell said that a “prolonged period of political uncertainty, coming straight after 5 years of Brexit uncertainty, would be unlikely to encourage global investors back to UK stocks.” A second Scottish referendum will be risky, but UK stocks are still cheap after a disappointing performance due to Brexit.

What would happen if the SNP were to win the majority?

If the SNP win a majority, Sturgeon has said that her party will seek a second referendum, and this is the reason that analysts are concerned. In a recent briefing to its clients, Berenberg has noted that the Scottish parliamentary elections could result in a majority for parties supporting Scottish independence.

The SNP currently rules in a minority government, but polling suggests that it is on course to win a majority, increasing pressure on Boris Johnson’s government to accept another independence vote.

An Ipsos Mori poll for STV News this week predicted that 70 of Holyrood’s 129 MSPs will be from the SNP, which means that Sturgeon’s party will get an 11-seat majority. Alex Salmond’s Alba Party has failed to have any affect in the polls, but his party as well as the Greens also support holding a second referendum. Any combination of the above parties will result in a pro-independence majority.

"Such an outcome could make waves in markets and refuel worries about the UK’s prospects following Brexit – which has raised the tail risk that Scotland may one day leave the UK to re-enter the EU as an independent country," says Holger Schmieding, Chief Economist at Berenberg.

The results of the 2014 Scottish referendum and the 2016 Brexit referendum have highlighted how uncertainty can affect Sterling exchange rates. The pound fell following concerns about the outcome of the 2014 independence referendum but immediately rose after it was clear that Alex Salmond’s independence movement was defeated.

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Pound volatility is expected to be high today and on Monday as the markets await Prime Minister Boris Johnson’s decision on whether the UK stays or leaves the Brexit negotiating table.

In the meantime, England is dealing with the rise of new Covid-19 cases and restrictions which will come into force under the government’s new three-tier system with London facing tighter restrictions from midnight on Friday.

Under this generalised gloomy climate, investors are waiting to hear whether the UK will continue with the Brexit talks. Last month, Johnson had set a deadline for a possible deal for the 15th October, and said that if nothing had been agreed, both sides should “accept that and move on.”

At a Brussels summit on Thursday, the EU proposed “two to three weeks” of negotiations. Investors are now closely watching to see whether the PM will try and resume the negotiations or stick to his threats and walk away.

Brexit pessimism pushed the pound lower against the US dollar, while it remained flat against the euro. At the same time, the prospect of tighter lockdown restrictions could further hurt the pound and threaten economic recovery. Jasper Lawler, head of research at LCG, said that more lockdown measures could push the UK and European economies into a deep recession: “The British government is under pressure to follow scientific advice for a 2-week circuit breaker national lockdown but has so far resisted, but has raised the capital to the Level 2 tier of restrictions. That means two different families can no longer mix indoors- be that in their home or in a pub or restaurant. There is still no sign of the joint European recovery fund so in the meantime economies stand to take the hit – risking a double dip recession – from the new restrictions.”

Angela Merkel urges Boris Johnson to keep negotiating over Brexit

The German chancellor has urged Boris Johnson to continue and not to walk out of the trade and security negotiations. In her comments that were designed to calm the atmosphere, Merkel said that both sides needed to find common ground: “In some places things have moved well, in other places there is still a lot of work to be done. We have asked the United Kingdom to remain open to compromise, so that an agreement can be reached. This of course means that we, too, will need to make compromises.” Her comments also come after Thursday’s summit where French president, Emmanuel Macron, demanded that the UK accept the bloc’s conditions or face a no-deal exit.

The EU had proposed a further “two to three weeks” of negotiations as the EU’s chief negotiator, Michel Barnier is scheduled to be in London on Monday to continue negotiations. Like Merkel, Barnier also said that the EU wants to give every chance to the negotiations so they are successful: “We’re available, we shall remain available until the last possible day.”

The UK’s chief negotiator, David Frost, expressed his disappointment after Thursday’s summit and tweeted: “Disappointed by the conclusions on UK/EU negotiations. Surprised EU is no longer committed to working ‘intensively’ to reach a future partnership as agreed with [the European commission president, Ursula von der Leyen] on 3 October. Also surprised by suggestion that to get an agreement all future moves must come from UK. It’s an unusual approach to conducting a negotiation.”

The foreign secretary, Dominic Raab, said that a deal was still possible: “We’ve been told that it must be the UK that makes all of the compromises in the days ahead, that can’t be right in a negotiation, so we’re surprised by that, but the prime minister will be saying more on this later today. Having said that, we are close [to a deal]. With goodwill on both sides we can get there.”

While challenges remain when it comes to the Brexit negotiations with the level playing field, fisheries, and governance, still unresolved, many are positive that there could be an agreement if significant work is done.

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