Sterling Buoyant Despite New COVID Restrictions

Sterling Buoyant Despite New COVID Restrictions

 Published: December 1st, 2021

GBP brushed off announcements from the weekend about new COVID-19 restrictions in the UK, starting the week higher on Monday alongside the recovery in global equities markets.

While the gains have so far been modest when compared to the amount of selling seen on Friday (26th Nov), analysts think it suggests that the investing community are sitting on their positions for now while they wait for new information from medical experts on the real dangers posed by the Omicron coronavirus variant.

In a note to investors published Tuesday, Capital Economics wrote that if Omicron ‘proves to be a false alarm, in the same way that fears about the Beta strain detected last summer turned out to be overheated, then risk appetite could bounce back quickly.

UK Prime Minister Boris Johnson said on Saturday that new restrictions to control the spread of the virus would be enacted and come into force on Tuesday, 30th Nov. A series of country-wide changes to international travel rules were announced last Thursday (25th Nov).

The arrival of new restrictions have been interpreted as a possible brake on economic growth and has led to markets lowering the odds for a December rate rise by the Bank of England.

Economists and forex analysts typically assume any deterioration in consumer and business confidence as a potential headwind to economic growth, as caution grows and spending slows as a new wave of the pandemic makes its presence known.

Much of the pound’s Friday dip was driven by the reduced odds on a near-term rate hike odds. Investors were betting that Threadneedle Street simply won't have the stomach for a rate rise against a backdrop of deteriorating sentiment.

Difficult decisions for the BOE

Ronald Weston, an Economist for NatWest Markets, told Bloomberg that the BOE faces ‘difficult decisions in the coming days and weeks, balancing a potential slowdown of the economic recovery with evidence that the cost of goods and services is rising even as labour markets tighten. The likelihood of a rate hike announcement from December’s Monetary Policy Committee meeting is probably receding’.

The pound-to-euro exchange rate had bounced back above 1.17 on Monday while the pound to dollar rate rose to 1.3338. That suggests some resilience in sentiment, both in broader markets and within the UK.

‘In American and Britain, governments have inched more towards a 'learning to live with the virus’ approach than the rapid lockdowns we’ve seen elsewhere. That raises the bar for implementing harsh restrictions, certainly higher than in Asia or Europe, where governments have already made tough new measures in response to the Delta variant’s recent spikes,’ said NatWest’s Weston.

An investor note from JP Morgan's currency trading desk in London said that ‘restrictions have moved up a level in the UK, but still look comparatively mild compared to other markets. We’re mainly looking at additional mask requirements and some tweaking of isolation measures at border crossings. Meanwhile, the government's vaccination booster program will be accelerated this week.’

Strategists at JP Morgan say Blighty is comparatively well-positioned in terms of a rapid rollout of the booster programme. That should support sterling if the UK could avoid a big spike in hospital admissions as a result.

‘The outlook for GBP is ever so slightly brighter if you consider that this new variant could add proof that the UK’s aggressive booster campaign was always the right strategy,’ says JP Morgan.

To date, boosters have proven to be particularly potent in managing pressures on the UK’s NHS health service created by the Delta variant’s rapid spread. That’s had the knock-on effect of muting calls for new economic restrictions.

A market analysis by Crédit Agricole’s FX Strategy unit said that the UK is ‘back to being the G10 leader in terms of vaccinations as a percentage of the total population. That’s giving forex traders confidence that the UK won’t move to new restrictions as a way to battle the pandemic.’

The worry is that the new Omicron variant degrades the effectiveness of vaccine protection, meaning markets will be watching closely for further announcements about the efficacy of vaccines and national vaccination programmes against Omicron in the near term.

Some economists have suggested Omicron isn’t enough of a worry to move central banks off their objective of normalising interest rates in the coming months. Given that the Bank of England has been leading the charge on the move to get rates back to higher levels, that idea taking hold could benefit the pound.

‘Unless a new strain creates significant widespread damage to economic growth, Omicron may not stop some central banks from hiking interest rates in 2022,’ says Capital Economics. ‘If Omicron turns out to be overhyped like last Summer’s Beta strain panic, risk appetite could bounce back quickly.’

Historically, sterling tends to benefit against the greenback and euro when investors are in a mood for bigger, riskier bets. However, the pound would probably take a back seat to commodity and emerging market fiats, which tend to do even better when market conditions are benign.

Forex strategists at Rabobank told Reuters that many of the outcomes anticipated for markets this week were blasted by last Friday’s news about the Omicron variant and the rapid implementation of various travel restrictions. Asset prices took a hit, and markets swallowed a bitter dose of reality. It had an effect on the outlook for Fed policy as well as money crises for GBP and EUR.’

The outlook will probably stay fuzzy for a few weeks, says JP Morgan, with investors unlikely to demonstrate enough confidence to open positions with much conviction: ’It’s simply too early in the outbreak to draw firm conclusions about the latest COVID mutation.’

Markets are effectively in a holding pattern,’ says the bank, until the WHO makes its first detailed assessment of the new variant, and major pharma manufacturers announce their plans to address it.’

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