The pound rose in response to Bank of England Governor Andrew Bailey’s comments that a 2022 rate hike is possible. While soon after, the pound was unable to hold its gains, the revelation by the central bank was important as it confirmed market expectations that a rate rise in the first half of 2022 is possible.

UK tax hike

The pound was higher, especially after it lost ground due to an announcement on Tuesday of a UK tax hike. The proposal, which on Wednesday was backed by British lawmakers in a parliamentary vote, intends to raise taxes to fund the health and social care systems. The government will raise the rate of National Insurance payroll taxes paid by both workers and companies by 1.25 percentage points. The tax on shareholder dividends will also rise by the same percentage. The plan is expected to help raise 12 billion pounds ($17 billion) a year.

Bank of England Vote to Raise Interest Rates

Andrew Bailey clarified that the eight members of the Monetary Policy Committee (MPC) were divided as to whether the UK economy was healthy enough for interest rates to be raised. In a testimony to the Treasury Select Committee of the House of Commons, Bailey noted that the vote was split: “Let me condition this by the fact that it was an unusual meeting because there were only eight members of the committee - so it actually was four-all.” In the August MPC meeting, however, all 8 members voted to keep interest rates unchanged. So, the bank feels more confident about the state of the economy now. Nonetheless, Bailey explained that the

Bailey said that the conditions were not yet sufficient. Markets expect the MPC to end quantitative easing in December before proceeding to raise interest rates. While Silvana Tenreyro did not believe that the conditions have been met yet, other members of the MPC including Bailey, Dave Ramsden and Ben Broadbent and Michael Saunders, all believed that the minimum conditions had been met for a hike. The remaining members of the MPC, Gertjan Vlieghe, Jon Cunliffe and Jonathan Haskel were possibly the more dovish members who believe that conditions have not been met yet.

Has the 2022 interest rate already been priced in by markets?

It would appear that it has been priced in by markets, as the pound was unable to hold gains. For the pound to strengthen, the Bank will need to provide more evidence of future rate hikes. If inflation stays above the Bank’s 2.0 % target, then the need to raise interest rates will rise too. The Bank’s economists expect inflation to rise 4.0% in 2021 but fall back in 2022. Bailey said that some issues could disappear, but unemployment and job vacancy issues could persist. Higher commodity prices and problems with supply chains could go away, but the labour market will need to improve consistently.  

Economists are concerned that after the end of the government's furlough scheme, unemployment will rise. But with many businesses finding it difficult to fill in their vacancies, the end of the support program might be positive.

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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 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 pound’s performance in the week ahead will be determined by yesterday's news that Covid restrictions will not be relaxed further until 19th of July. On Tuesday, Wednesday and Friday, investors will focus on the releases of a series of market data, including employment data, inflation figures and UK retails sales numbers, respectively. With investors being interested to see how well the UK economy is recovering, and how the Bank of England will eventually respond by raising interest rates, any sign of strong data will be pound positive.

Covid restrictions

On Monday, markets reacted to the news that the UK government will not fully relax Covid restrictions on 21st June as planned due to the rise of Covid-19 infections over the past week. British Prime Minister Boris Johnson may also announce further government support for businesses, as junior health minister Edward Argar said on Monday.

Foreign exchange markets had already priced in a possible delay, so the news has not provided any immediate volatility. 

However, if the Indian variant of the coronavirus pushes infections and hospitalisations up and the vaccines do not prevent a rise in cases . hospitalisations and deaths, then the pound may be vulnerable to volatility down the line. Foreign Secretary Dominic Raab had said on Sunday that the government’s decision on ending Covid restrictions on 21st of June would depend on whether there was no link whatsoever between infections and hospital admissions - so the change suggests that this is the case.

Economic Data

The coming week will also see a number of important economic data releases, which if they come out strong, then this could prompt the BoE's Monetary Policy Committee to start thinking of terminating its quantitative easing programme before raising interest rates in 2022. This scenario will support the pound.

  • Employment data

On Tuesday, with the release of employment data, investors will be looking to see whether 50K jobs in the three months to April have been added to the economy. The unemployment rate is forecast to come in at 4.7%, down from 4.8% previously. If numbers are better, then the pound will find further support, while any move lower could impact on the pound in the near-term.

  • Inflation numbers

On Wednesday, May inflation numbers are expected to show an increase of 1.8% year-on-year, up from 1.5% previously.  This is almost the mid-point of the Bank’s 1%-3% target range. This will be positive for the pound.

UK retail sales

On Friday, UK retail sales figures could be up, with a reading of 36.8% growth year-on-year in May, which could boost consumer confidence.

The data predictions are generally optimistic and any digression from the numbers could hurt the pound and disappoint the markets.

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Brexit is back in the picture, as there are talks of a potential trade war between the UK and EU over the coming days after both sides failed to reach agreement on the Northern Ireland protocol. The EU has threatened to impose sanctions on UK exports to Northern Ireland if it fails to implement the terms of the Northern Ireland protocol next month. If things escalate, the pound will also be affected, as it usually falls when concerns around Brexit rise.

EU press conference

On Wednesday, UK and EU officials met in an attempt to resolve any disputes over trade rules for Northern Ireland. In the EU press conference following talks with Lord Frost on Northern Ireland protocol, Maroš Šefčovič, the vice-president of the European Commission who serves as the EU’s lead on post-Brexit negotiations with the UK, said that fundamental gaps remained in the UK’s implementation of the deal. On the Northern Ireland protocol, both sides agreed in 2019 this was the best solution to protect the Good Friday agreement. In December last year some solutions were agreed, including grace periods and exemptions in areas where the UK was not ready to implement the protocol. But he highlighted that “we cannot undo the core of the protocol”, as there are still “numerous and fundamental gaps” in the UK’s implementation of the deal.

He also confirmed that the EU could take retaliatory action. Šefčovič says the EU is a peace project, and, as he said, he did not arrive with a list as he is looking for a solution. But he did confirm that the EU could impose tariffs on some UK goods if the Northern Ireland protocol was not implemented. The protocol is designed to prevent checks at the border with Ireland. So, the EU agreed to let the UK conduct these checks at the GB/NI border. The easiest thing would be for the UK to accept EU SPS standards. Nonetheless, Šefčovič says he has a good and honest relationship with Frost and believes in Frost’s “best intentions”.

How will the pound react?

If the relationship with Brussels breaks this could weigh on Sterling sentiment in the short-term. If the EU does take any retaliatory action, and tensions escalate, then the possibility of the UK losing access to the single market would raise significant risks for the UK economy and hurt the pound.

The Prime Minister’s spokesman said: "The protocol was formed in a spirit of compromise, in challenging circumstances. It was not a finished solution... and we didn't expect the EU to take such a purist approach to it. We are working very hard to resolve these issues consensually. But the Prime Minister has always made clear we will consider all our options in meeting our responsibility to sustain peace and prosperity in Northern Ireland.”

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The British pound has come under pressure as there are concerns that the UK’s exit from the lockdown will be delayed. With Covid-19 cases on the rise, the government might postpone the final unlocking due on 21st of June. As Health Secretary Matt Hancock said, the government is "absolutely open" to delaying its plans to ease the restrictions, with a possible two-week delay until the 5th of July. This means that any possible delays will affect confidence in the UK economic rebound, and, consequently, hurt the pound which has had a solid performance throughout 2021.

Lockdown Easing, Indian variant and pound performance

Covid restrictions easing could be disrupted as scientists believe that the Indian variant (known as the Delta variant and B.1.617.2) could spread almost 50% faster than the previous strain in the UK, known as the Kent variant. While the Indian variant might be the cause for potential delays, many analysts believe that this is not enough reason for investors and traders to become especially concerned about the pound’s outlook, as the backdrop remains positive. As economists at ING Bank said, "a 'June pause' probably won't significantly derail the UK's recovery,” unless market confidence “goes into reverse.”

This will also be influenced by how strong business and consumer confidence will be as they will determine whether there will be the necessary funds and investment to drive economic growth. Economic data has up till now been positive with increased bookings in restaurants and pubs, as activity picks up. Economists believe that economic growth data for the second quarter of 2021 will be stronger than many have anticipated, and this will offer further support to Sterling. The potential for the UK economy to beat expectations could also increase confidence and possibly drive the Bank of England (BoE) to raise interest rates sooner than expected.

For the pound but also for other currencies, positive news that central banks will exit their pandemic support programmes will offer extra support. Already, we have seen that for those central banks which have reduced their quantitative easing programme and signalled that interest rates will rise, have seen their currencies outperform.

In general, the majority of analysts believes that the pound will benefit as the economy improves in the coming weeks and months, driven mostly by consumer savings during the various lockdowns. However, a rising number in Covid cases and further restrictions could dampen sentiment.

Short-lived pound weakness

For many economists and research analysts, a potential delay in the easing of restrictions will be damaging, but for others, such weakness will only be short-lived. It is believed the pound will be sold briefly by traders, but then renewed interest will resume.

While the pandemic will continue to affect the economy and the pound, other factors such as economic performance, vaccines, and rising UK real yields will also have an impact on the pound’s performance.

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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 strengthened as a result of a combination of factors including the reopening of businesses in April which helped support the pound at the start of the new week. April has been a typically good month for the pound with gains historically occurring in the second half of the month, and this could also be partly the reason. Foreign exchange strategists believe that this could be enough for the pound to continue trading well against the euro, especially with many economic data due to be released this week.

Economists and traders are expecting that this week’s economic releases will be proof that the UK economy is recovering as businesses reopen and the quick vaccination programme continues. With inflation coming out on Wednesday and the PMI survey for April out on Friday, markets are optimistic that the data will support the view that the UK is on track for a quick economic rebound. The PMIs are expected to show that economic activity is increasing as restrictions have been eased.

UK economic rebound

The pound has experienced a solid year, as investors speculated on a quick economic recovery due to growing confidence in the vaccine rollout programme. The UK economic outlook has improved the past few months as the successful vaccination programme supported a strong Sterling. Financial analysts and investors forecast that the UK economy will recover as more people are able to go out and spend money in retail shops. Already, there is an increase in shopping following the three-month lockdown, when on 12th of April non-essential stores reopened.

UK businesses report better than expected sales

With many UK businesses reopening, trading has increased as consumer demand was higher, and the reopening proved to be a success confirming that a strong rebound in the second quarter is possible. The ability of consumers to spend was also due to the government’s important furlough scheme which protected consumer income. From bank transactions to restaurant bookings and shop visits, it was evident that people were eager to spend when businesses reopened on 12th of April. Already, the first three days after the reopening, visits to retail and other shops increased instantly, pointing to a sharper recovery than initially expected.  

Consultancy Springboard’s statistics showed that footfall last week across all UK retail shops was 25 per cent lower than in the same week of 2019. However, the gap narrowed by more than half in a single week, reaching the level of trading after two months following the first lockdown. Retail parks was the major driver behind the surge, which was only 2 per cent down when compared with the 2019 level. Diane Wehrle, insights director at Springboard, described the first week of reopening as “an outstanding performance” for the UK retail sector and that with the reopening of indoor hospitality on 17th of May 17, “a further boost” to retail destinations is also to be expected.

Fable Data statistics also showed that spending in pubs and restaurants recovered to 42 per cent and reflected similar numbers in restaurant bookings tracked by Open Table. Government figures on public transport also showed that people were on the move, while vacancies also increased to pre-pandemic levels in April. Such measures showing people’s mobility, shopping and restaurant bookings are increasingly considered crucial indicators of the health of the economy and much more accurate when compared to official economic numbers. These near-real-time indicators reflect a more accurate picture of the economy as economists are hopeful that everything is going as well as could have been hoped.

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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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Sterling rose on Tuesday (02/02/2021) for the first time since last spring, after the GDP report showed that the eurozone GDP shrank by 0.7% in the last quarter of 2020 and will probably keep shrinking in the current quarter. While this is not as bad as it was expected, fears of a eurozone double-dip recession have risen. Following the news, the euro fell to a nine-month low against the pound. The euro has also dropped to a seven-week low against the US dollar.

For many economists, the EU’s inability to secure a quick vaccine rollout, the prolonged lockdowns and the prospect of further ones will continue to impact on the euro. Additionally, concerns about a double-dip recession are also weighing on the euro. Due to the slow vaccine rollout and the EU’s poor vaccine strategy, commission president Ursula von der Leyen has drawn criticism and had to respond by claiming that the UK’s vaccination programme had compromised on “safety and efficacy” safeguards to get a head start. She said that “Some countries started to vaccinate a little before Europe, it is true. But they resorted to emergency, 24-hour marketing authorisation procedures.” Von der Leyen has also been criticised by Jean-Claude Juncker, but she said that she should be judged in 2024 when her term ends.

Europe’s slow vaccine rollout could affect economic recovery

The slow start to Europe’s Covid-19 vaccination programme could affect its recovery, according to economists. Sam Miley, economist at the Centre for Economics and Business Research said: “The downtick in economic output in Q4 reflects the widespread reimplementation of Covid-19 contain measures across the continent, though does mask varying degrees of restriction severity across member states. This downward pressure on economic output looks set to continue in early 2021 due to the clampdown on new, more virulent strains of coronavirus, while subdued economic activity could continue for an even more protracted period in light of the eurozone’s relatively slower rollout of vaccinations.”

Other economists are also warning that the eurozone is possibly in a double-dip recession now. Christoph Weil, economist at Commerzbank, explained that eurozone GDP will continue to shrink in the January-March quarter, after the 0.7% decline recorded in October-December. “In the first quarter of 2021, the decline is likely to be somewhat steeper. However, there will not be a slump like the one in the first half of 2020. Instead, a noticeable recovery is likely to set in again from the spring.”

Global Chief Strategist at HSBC Global Asset Management, Joseph Little, said:  “The negative Q4 GDP print is confirmation of what investors already knew – a double dip recession in Europe at the end of 2020, with that weakness continuing through Q1. The live question for investors is what the delays in vaccine distribution and virus trends means for the growth outlook as we go through the year. We think the picture should improve through the summer, and that facilitates a ‘catch-up’ phase of growth for Europe in H2.”

UK vaccine rollout

Sterling rose due to optimism about the UK’s vaccination rollout and a wider positive risk sentiment.

The government is expected to vaccinate 15 million with the first dose of the vaccine by the middle of February so all who are clinically vulnerable have some level of resistance against the Covid-19 virus. If the vaccine programme goes as scheduled this, together with the strict lockdown measures will eventually allow the UK government to relax some of the restrictions. This will also help boost the currency. JP Morgan said: "We generally remain supportive of the stronger Sterling view given the impressive vaccine roll out the UK has implemented. Of course, short-term virus worries remain a headwind, particularly as UK lockdowns look set to stay for a significant amount of time.”

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