The pound started the new year strong as it rose against the US dollar on Tuesday and Wednesday. Analysts say that the strengthening is due to investor optimism about the effects of the Omicron variant of Covid-19 which has been less disruptive to the economy than originally expected. Investors are also optimistic about a potential Bank of England interest rate rise as early as next month.

On Thursday, the pound was lower as the US dollar strengthened following the Fed meeting minutes which showed that the Bank was more hawkish than expected. These has created concerns about faster than expected tightening of the Fed’s monetary policy which along with rising inflation will require the Bank to act and raise rates sooner than expected.

Services PMI data was higher than the preliminary reading, but it showed that the UK services sector lost momentum last month due to the lockdown, with the hospitality and travel sectors being affected the most.

Omicron restrictions ease

While the Omicron variant has affected a high number of UK citizens, the Prime Minister Boris Johnson avoided stricter lockdown measures and on Wednesday he announced that a pre-departure test was not needed when travelling to England.

Markets also appear to have decided that Omicron concerns are over, and investors are now focussing on the prospect of wider global reflation. Reflation refers to attempts to bring the economy back up to the long-term trend following a dip by increasing the money supply or by reducing taxes. The pound is considered to be a "pro-reflation" currency, according to analysts.

For the markets, the prospect of further restrictions is very low considering that the government is against such measures.

Bank of England rates

Markets are expecting further interest rate hikes from the Bank of England, as they have already priced in 100bp of rate hikes in the next 12 months.

With the Bank demonstrating that is willing to raise rates despite Omicron concerns and additional political support for the November rate hike from Chancellor Rishi Sunak, markets are optimistic.

Currency markets are pricing in two rate rises by the Bank’s March meeting and a full percentage point by the end of the year.

The Bank raised interest rates for the first time in three years in December, despite the Omicron variant and at a time where thousands of people were forced to self-isolate. Financial markets expect a second interest rate rise from the Bank in February from 0.25pc to 0.5pc.

Despite market optimism, economists have warned that household savings are falling as higher prices are eating into budgets. At the same time, lenders are said to have the ability to lend and mortgage rates are expected to be competitive in the near future.

In the meantime, Andrew Sentance, who was a member of the Monetary Policy Committee between 2006 and 2011, intends to push for an investigation into the Bank of England’s role in raising rates and he will write to the chairman of the Treasury Select Committee and former Cabinet Minister Mel Stride this month. He criticised the BoE for being “dormant” and reluctant to take action.


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