Sterling Pound Set to Continue Outperformance

Sterling Pound Set to Continue Outperformance

 Published: February 23rd, 2022

Sterling's strong start to 2022 pushed through mid-February, and Britain's fiat looks ready to benefit from an after-Omicron economic rebound, plus expectations that the UK's central bank is readying new interest rate hikes.

Numbers from the Office of National Statistics (ONS) showed that retail sales lifted by nearly two per cent month-on-month in January, beating consensus forecasts of one per cent and leaping ahead of December's negative four per cent reading.

In a market analysis published the week of February 21st, ING's FX Strategy Unit said that UK retail sales came back in January with a vengeance as the Omicron worries began to dissipate. 'Sterling now looks relatively less exposed than to adverse swings in geopolitical sentiment than the Euro and nordic currencies like Norwegian Krone.’

ONS data also shows commuter travel in Britain's most significant cities bouncing back to pre-Omicron levels, supporting expectations that February will be remembered as the start of a solid rebound in growth.

ING says the latest bus, train and mobility numbers show that offices and services in central London are now about as busy as they were before Omicron.

The figures arrive after Westminster announced the end of all Covid-19 related restrictions in England, even eliminating the strict testing measures that had been in place for travel, after determining that Omicron is much less deadly than earlier waves of coronavirus.

Coming back to life

Near-term indicators paint a picture of an economy coming off life support after a dull December-January. February 20th marked the fifth consecutive week of increasing retail footfall. The ONS also found that UK purchases of restaurant (seated) meals rose by 17 percentage points to levels equivalent to the same week in 2020.

Altogether the numbers could provide support for Bank of England policymakers eager to announce another interest rate rise in March, progressing a cycle that has helped push-up Sterling’s value in late-2021 and early 2022.

Economists at Barclay's wrote in a note to investors that the BOE's next rate step is likely coming in March and that the bank 'currently expects three additional rate steps over the next three quarters of 222.'

Sterling also had a fillip from two other consensus-beating data releases. Wage and job numbers released the week of February 21st confirmed that the UK's job market is 'tight' with not enough candidates available to take on record-high job vacancies.

BoE rate hikes are also being driven by the economy's higher inflation levels, which rose to 30-year highs in January.

But some analysts counsel caution

Some forex strategists are urging caution despite the positive indicators. They say pound investors could be pricing in more BoE rate hikes than the bank is likely to deliver.

Mike Pederson, a forex analyst at Danske Bank, told Bloomberg that while the pound may be supported by further rates action in March or May, 'the impact of hikes could be priced-out rapidly, eliminating any early mover advantage.

He said the European Central Bank (ECB) is also set to raise its key rate in September or October, 'so we believe the situation for the euro will need to be revised. Currency traders will have to adjust expectations for the pound's key rate to the downside at some stage.'

If the market is going to sustain its high-rate hike expectations for the Pound, British inflation expectations will also have to move considerably higher.

'If anything, relative interest rates could turn into a drag if traders start to price in a more aggressive stance from Frankfurt and less aggressive action from Threadneedle street. For that reason, it's our view that 0.84 was the bottom for EUR/GBP this year.'

Barclay agrees that 0.84 for EUR/GBP indicates a sort of ‘the end of the line’ where strength in the pound is likely to have peaked.

‘Achieving price levels below that does not seem sustainable from our analysis. If they do occur, traders should prepare for them to be very brief excursions before a quick pullback.’

Banker Julius Baer is maintaining a forecast of 0.82 for the EUR/GBP pair over the next three months, which hands GBP/EUR a basis point forecast of 1.21. Looking ahead six months, however, the bank is looking for EUR/GBP to reach 0.83, which translates into GBP/EUR at 1.20.

'A sluggish longer-term UK growth outlook and the potential for inflation to drop back below BoE targets in two years suggest that the four rate hikes markets have priced in for this year are too optimistic. We believe a hike in May or before could happen, and maybe one additional rise in the summer. After that, we see a holding pattern from the BoE.'

Omicron’s impact less than feared

Despite post-Brexit worries and the ongoing pandemic, Britain’s economy has weathered the Omicron outbreak better than had been expected. This week’s ONS figures have prompted widespread speculation that Blighty is already bouncing back from its autumn 2021 setback.

Britain's GDP dropped by 0.2 per cent in December 2021 when businesses and households were compelled to scale back spending after the November emergence of the Omicron variant of COVID-19, leaving the economy growing at a rate of one per cent in the closing quarter of the year.

Economic consensus estimates were pointing to a more considerable half-percentage point decline in December; however, the final quarter expansion may have been statistically impacted when the Office for National Statistics revised down forecasts for UK third-quarter growth from 1.2 per cent to just one per cent.

Nick Sajani, a UK economist at Lloyds Commercial Banking in London, told Reuters that Omicron's negative economic impact seems to be on the wane since most restrictions on commerce and travel have now been removed by the government. ‘We can’t say yet if GDP will drop again this quarter but indications that activity bounced back sharply in February point to a sizeable increase in GDP for the first quarter of 2022.’

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