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The Pound Can Continue to Outperform says Barclays

Researchers at Barclays describe the British Pound’s recent performance as “resilient” as they anticipate the currency to continue outperforming key peers over coming weeks and months.

Gains for the currency come amidst ongoing expectations for a February rate hike at the Bank of England, easing Covid-19 cases and a lack of concern shown by investors to the woes befalling Prime Minister Boris Johnson.

Barclays says in a regular weekly currency market briefing that the Pound was the best performing G10 currency in the first week of 2022, helped by a positioning unwind and expectations for a February interest rate hike.

They find further outperformance can be expected should these two themes continue to play out over coming weeks.

The market now anticipates a ~75% chance of a second rate hike coming from the Bank of England at the February 03 policy meeting, odds of which have in turn been boosted by expectations for a more ‘hawkish’ U.S. Federal Reserve in 2022.

As Pound Sterling Live noted here, expectations for a ‘faster and sooner’ Fed rate hiking cycle provides the Bank of England with welcome cover to pursue its own rate hiking agenda.

Inflation in both the U.S. and UK are at multi-year highs and policy makers have warned the pandemic-driven boost to prices are not as transitory as they and many economists had anticipated at the start of 2021.

Therefore the market thesis, for now at least, appears to be that higher interest rates in the U.S. means higher rates in the UK, in turn supporting Pound Sterling.

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A February rate hike at the Bank of England would be the second lift in just two months. But how many hikes will be delivered in 2022 in total could prove to be a crucial determinant of how high the Pound can go.

“The Bank of England’s surprise December rate hike caused an immediate repricing of further near-term rate hikes. However, the rates market has historically struggled to price in a terminal BoE rate much above 1%,” says Erick Martinez, FX Strategist at Barclays.

Martinez says the start of 2021 has seen markets solidify pricing for the February and May 2022 meetings but, more importantly, succeeded in pricing in an extended hiking cycle, “with the GBP OIS curve significantly higher at the three-year maturity”.

Another driver of Sterling outperformance is repositioning amongst investors, finds Barclays.

According to CFTC data – the most widely referenced data set showing how currency participants are positioned – GBP positioning is still net short and was at its most extended in 19 months heading into the new year.

When the market is heavily ‘short’ against a currency a counter-trend shock can force these positions to unwind, creating a technical momentum that delivers further gains.

Investors will likely continue to exit the net short position built up against the Pound over coming days and take the market to a more balanced state.

But it would only be when a net ‘long’ position builds up – as was seen in the first part of 2021 – would positioning begin to become a headwind for the UK currency.

For now Barclays says the path of least resistance for Sterling is higher in the near-term.

“We continue to expect GBP to perform well in the coming week as these drivers gain further traction,” says Martinez.

Barclays hold a 2022 forecast profile for the Pound to Dollar exchange rate of 1.33 for the end of the first quarter, 1.37 for the end of the second quarter, 1.40 for the end of the third quarter and 1.42 for the end of 2022.

Their forecast profile for the Pound to Euro exchange rate is 1.15 for the end of the first quarter, 1.16 for the end of the second quarter, 1.18 for the end of the third quarter and 1.19 for the end of 2022.

The greater returns against the Dollar are explained by their against-consensus view that the U.S. Dollar will struggle in 2022.

“Positioning suggests that long USD is the consensus trade for the beginning of the year. However, consensus trades have historically performed poorly during the first quarter. Against market consensus and positioning, we continue to expect modest USD depreciation over 2022,” says Martinez.

Data from the CFTC shows the market remains ‘long’ on the Dollar, a position adopted by the market as far back as mid-2021 when the currency started to outperform peers in anticipation of a withdrawal of stimulus at the Federal Reserve.

Investor expectations for ‘more of the same’ in 2022 appear intact at the start of the year but the risk is that such crowded positioning in fact acts as a headwind to further upside.

Barclays finds that since 2013 consensus trades during the first few months of the year only performed well in 2015 (short EUR/USD) and modestly well during the beginning of last year (the reflation trade).

“This could be the result of crowded positioning, as markets had already pre-positioned for those trades at year-end,” says Martiznes.

Barclays hold a thesis that coming months will see a positive backdrop for risk and commodities and subsiding safe haven demand as the Omicron wave burns out.

Bond yields on U.S. government debt have soared to multi-month highs at the start of 2022 as investors price in up to four interest rate hikes at the Federal Reserve over the duration of the year, as well as the commencement of quantitative tightening.

Typically such dynamics would be positive for the Dollar as they imply greater returns for foreign holders of such assets.

But Barclays hold a view that U.S. rates will remain rangebound, underpinning “our moderately bearish USD outlook,” says Martinez.

Written by Gary Howes

Source: PSL

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UK economy to shrug off Omicron quickly but lean into inflation blizzard

The UK economy will shrug off the impact of the Omicron variant quickly, but will then fall into an inflation blizzard, top City economists have bet.

Despite widespread concerns the new strain would plunge the economy back into doldrums seen during previous periods of high virus cases, the impact of the Omicron variant will be mild.

Covid-19 cases are seemingly peaking in London, the capital’s health chief said this week, in a sign that the UK government’s decision to stick to plan B has paid off.

The likelihood of further curbs on daily life being introduced has receded significantly, igniting a string of bullish assessments from top City experts on the UK economy’s prospects.

“The worst of the Omicron wave now is behind Britain,” said Smauel Tombs, chief UK economist at Pantheon Macroeconomics, adding he now expects plan B measures to expire at the end of January.

The UK economy has snapped back sharply after previous waves of the virus have filtered through the country, indicating output will propel higher beyond January. Pantheon have hiked their forecasts for UK economic growth for the first three months of the year to 0.2 per cent from zero.

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Andrew Goodwin, chief UK economist at Oxford Economics, said: “With Omicron rapidly moving through the population, this wave should prove short-lived.”

“Activity is likely to rebound strongly as case numbers fall, so GDP should return to pre-Omicron levels in early spring.”

“Restrictions now look likely to be soft in scale and shorter in duration, with the economy potentially reversing restrictions over the next month,” said Sanjay Raja, senior economist at Deutsche Bank, said:

Most in the City now think the economy will hit pre-pandemic strength in the first half of 2022.

In a sign that Britain’s recovery was already steaming ahead before the emergence of Omicron, Friday’s GDP print is expected to come in strong.

Analysts at investment bank Deutsche Bank are pencilling the economy to expand 0.4 per cent in November, up from 0.1 per cent in October, driven by a rise in consumer spending.

However, the soaring cost of living is now seen as the number one risk to derailing Britain’s recovery among experts.

“It’s highly unlikely that pay will keep pace with price gains for most (if not all) of this year. That will cap consumer spending growth,” warned James Smith, developed market economist at ING.

Some experts in the City think inflation could top seven per cent this April, led higher by the energy watchdog, Ofgem, hiking the cap on energy bills 50 per cent.

By JACK BARNETT

Source: City AM

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UK inflation to remain more than double BoE’s target for entire year

UK inflation will run at more than double the Bank of England’s two per cent target for a whole year, reveals fresh forecasts published today.

The rate of price increases will peak at 6.7 per cent this April, lifted higher by the energy bill cap being hoisted around 50 per cent, according to investment bank BNP Paribas.

October’s 2021 official inflation rate hit 4.2 per cent. BNP Paribas predict the rate will not fall below four per cent until November this year, meaning the cost of living will remain at least double the Bank’s target for an entire year.

Inflation does not fall back to the Bank’s target until April next year under the investment bank’s forecasts.

Soaring wholesale gas prices triggered by an energy crunch in Europe, compounded by supply chain breakdowns and a tight labour squeeze has propelled inflation in the UK to historically high levels.

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The cost of living is already running at its hottest rate in over a decade, hitting 5.1 per cent in November, according to the Office for National Statistics.

Households are set to be squeezed by inflation eroding real incomes and the Bank hiking rates rapidly in response to the rapid cost of living increase.

Consultancy Capital Economics is pricing in four rate hikes in 2022, taking borrowing costs 1.25 per cent, the highest level since February 2009.

The predictions come as the International Monetary Fund warned yesterday emerging market economies need to prepare for potential currency fluctuations and financial market volatility triggered by the world’s top central banks tightening policy sharply this year.

The Bank will announce its next decision on interest rates on February 3. Last month, the central bank raised rates for the first time in over three years, lifting them 15 basis points from a record low 0.1 per cent.

By JACK BARNETT

Source: City AM

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Mortgage arrears fall to lowest level since mid-2000s

New mortgage arrears cases have reached their lowest level since the global financial crisis of 2008, but rate rises could lead to more arrears, a tax advisory firm has warned.

According to Paul Rouse, partner at Mazars, there were just 8,597 new cases of arrears by the end of 2021, compared to 40,000 a quarter at the height of the global financial crisis.

But Rouse warned this good news might not last, with an increase in arrears seemingly ‘unavoidable’.

He said given the Bank of England’s recent interest rate rise from 0.10 per cent to 0.25 per cent – and more on the horizon in 2022 – it may be “inevitable” that more mortgages fall into arrears.

Over the past decade, record low interest rates created an environment where homeowners had been able to avoid arrears as mortgage providers followed the BoE’s base rate down.

In recent years, increased savings and reduced expenditure during lockdown and the effects of the furlough scheme have also contributed to driving mortgage arrears down.

Banks also contributed to the low level of defaults on mortgages by following Financial Conduct Authority guidance in 2020 to show forbearance to borrowers in difficulty during the pandemic.

According to Mazars/BoE data, the total number of mortgages in arrears is also near record lows, with 122,061 cases in total in the UK at present.

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But inflation has reared its head, with UK GDP having been widely forecast to increase by nearly 5 per cent in real terms this year, and inflation expected to touch 6 per cent and unemployment at just over 4 per cent.

Rouse said: “With interest rates rising to combat inflation – we may in turn see mortgage arrears and rates go up soon. If the Omicron variant persists it may delay the rise but an eventual increase is inevitable.

“The danger if interest rates continue to rise some who have been comfortably repaying their mortgages may begin to struggle.

“While the vast majority of home owners can repay their mortgages at the current interest rates without difficulty, many would find it significantly more challenging if interest rates were 5 per cent or higher.”

Lower rates for longer?

In March 2009, the BoE put the rate down to 0.5 per cent, the lowest level it had been since October 1694, when the Bank first began recording rates.

It stayed at this level until August 2016, when it dropped briefly to 0.25 per cent following the vote to leave the EU in June of that year, before rising again to 0.5 per cent in 2017.

Since then, the BoE merely tinkered with the levels, dropping them to 0.1 per cent as a result of the Covid-19 pandemic.

With lower base rates, borrowers have enjoyed lower levels of interest on their mortgage loans.

Even at the start of 2022, mortgage lenders were lowering some rates to encourage potential homeowners.

For example, the Nottingham welcomed in 2022 by announcing rate drops of up to 70 basis points across its residential range.

Its two-year fixed 80 per cent LTV product with £1,499 (£199 upfront) fees was reduced from 2 per cent to 1.3 per cent, while the building society cut the rates of two and five-year fixed products – all available for purchase or remortgage – at 85 per cent and 95 per cent loan-to-value.

Meanwhile, mortgage approvals are also still high and likely to remain so for much of 2022.

Kimberley Gates commented: “The stamp duty holiday helped spur a huge flurry of homebuyer activity for much of 2021 and so a steady decline in mortgage approvals was always likely to materialise following the final September deadline.

“However, this decline should be viewed as a return to pre-pandemic normality rather than a sign of dwindling health and the market continues to defy expectation and exceed industry forecasts where top-line performance is concerned.”

She said while 2022 was “unlikely” to bring the same frantic market conditions as the last year, Sirius does not expect there to be a significant reduction in buyer demand and therefore any further notable decline in mortgage approval levels.

By Simoney Kyriakou

Source: FT Adviser

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Sterling edges up despite cooling UK economic data

Sterling was on track on Friday for weekly gains against the dollar and euro to start 2022, despite a mixed picture emerging for Britain’s economy.

The currency has strengthened since mid-December in part due to the Omicron variant of COVID-19 proving less disruptive to the economy than originally feared, analysts have said, with the government only lightly tightening restrictions so far.

Sterling was heading for a 0.4% gain versus the dollar for the week and 0.6% up against the euro.

On the day, the pound was up 0.3% versus the dollar at $1.35720.

Sterling’s gains partly reflected a weaker dollar across the board, after a December U.S. jobs report missed expectations.

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Against the euro, the pound fell 0.2% to 83.585 pence per euro.

Economic survey data this week showed Omicron has had an impact. Survey data for Britain’s construction sector on Friday showed growth cooled in December, falling to a three-month low.

A similar Purchasing Managers’ Index (PMI) survey for the services sector on Thursday showed the biggest loss of momentum since the country was last in lockdown, falling to a 10-month low in December.

The pound has nonetheless broadly maintained momentum versus the dollar, rising from a one-year low of $1.31615 hit in December.

Investors will closely watch to see if the Bank of England will further tighten policy, with a further interest rate rise expected as early as next month after a surprise hike in December.

Source: Reuters

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UK Economy Looks Forward to a February Bounce-back

The UK economy will shrink during the months of December and January but looks set to rebound in February, according to new research.

Analysis from independent economic and financial research provider Capital Economics finds GDP could fall by as much as 1.0% during December and January, even if further restrictions are not introduced by the government.

“We aren’t factoring in any additional UK-wide restrictions, but we still expect increased consumer caution and self isolations to weigh on economic activity in the first quarter,” says Adam Hoynes, Assistant Economist at Capital Economics.

Prime Minister Boris Johnson on January 04 said the UK would likely see out the Omicron wave of infections without the need for further restrictions, while it was confirmed by Cabinet on Wednesday that existing Plan B measures would be maintained.

The economic costs of existing Plan B restrictions when combined with voluntary caution and self-isolation are however likely to prove significant.

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“We now think that GDP will fall by around 1% over December and January together,” says Hoynes. “The number of people forced to self-isolate is becoming increasingly disruptive.”

Data from the ONS showed the spread of Omicron was met with a decline in card spending, mobility and internet searches related to social activities during December, raising expectations or a sharp drop in economic activity.

“Consumer caution in response to Omicron points to a near-1% fall in GDP between November and January,” says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.

Further constraints to output in all sectors will come amidst a surge in the numbers of people having to self-isolate, having caught the virus.

To highlight the sale of the current infection wave, the ONS said on January 05 that 1 in 10 people in London had Covid in the week ending December 15. 1 in 15 in England had the virus, 1 in 20 in Wales, 1 in 25 in Northern Ireland and 1 in 20 in Scotland.

Health minister Gillian Keegan said on January 05 that “around a million people are now self-isolating”.

The impact on businesses is significant, a point highlighted by Iceland Managing Director Richard Walker who said 11% of their workforce were now self-isolating.

“The number of people forced to self-isolate is becoming increasingly disruptive,” “it it appears that the recent surge in positive cases is beginning to offset the relaxed isolation rules,” says Hoynes.

Pantheon Macroeconomics anticipate output in the accommodation and food services sector to have fallen by about 15% month-to-month in December with a further 5% fall to come in January.

They assume output in the arts, entertainment and recreation sector dropped by 10% in December and will fall by a further 5% in January.

Output in the transport sector is anticipated to have declined by 3%, and will drop by a further 3% this month.

Covid cases in London look to have peaked already in what amounts to a potential precursor to a peaking in other regions across the UK in January.

This suggests February could see substantive easing in pressure on businesses and consumer activity can recover.

Capital Economics expects economic growth losses suffered in December and January to be recouped in February and March, “if Omicron cases fall as fast as they rose”.

Pantheon Macroeconomics says Omicron appears to be dealing a substantial blow to economic activity at the turn of the year, “but the good news is that GDP should be rising
again in February”.

“In Q2, GDP should be close to the level it would have reached, had the new variant not emerged,” says Tombs.

Written by Gary Howes

Source: Pound Sterling Live

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What does 2022 have in store for the UK economy?

Growth slowed more than expected in 2021Q3, with the GDP increase revised down to 1.1% (QOQ) from 1.3%. Moreover, the Markit surveys suggested activity slowed in December.

Nevertheless, assuming there are no major extensions to Covid-related restrictions, growth should continue into 2022 and GDP could show annual growth of 4% after 7% in 2021.

Prospects are, however, clouded by higher inflation, partly driven by higher energy bills, which will squeeze household incomes. Households are also facing higher taxes and higher interest rates (to over 1% by end-2022, priced in by the markets).

Markit surveys for December suggested growth had stalled in Germany but was still firm in France. US growth also looked firm, though inflationary pressures continued to mount.

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Lord Frost resigned as Minister of State in the Cabinet Office and Chief Negotiator of Task Force Europe on 19 December. Foreign Secretary Liz Truss assumed his Brexit responsibilities.

Ruth Lea said “Even though growth should continue into 2022, prospects are clouded by uncertainties. The two main ones are, arguably, the possibility of tighter Covid-related restrictions and, secondly, inflation and the future trajectory of oil and gas prices, major rises of which have been driving inflation higher. On the possibility of tighter restrictions, the Prime Minister has resisted imposing further restrictions so far and, moreover, appears reluctant to do so. Concerning inflation, the annual rate should fall back in 2022H2, not least of all reflecting base effects, assuming there are no further major hikes in energy prices. Indeed, prices may reverse if production is stepped up. But this assumption is a very big, and very uncertain, assumption”.

Source: LLB

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Inflation will get worse before it gets better in 2022

Investors should brace for high inflation to persist into next year if supply chain hold ups are not dealt with, according to experts.

Towards the end of 2021 the impact of higher prices was already being felt. Stocks wobbled while bond prices rose as central banks began taking measures to combat higher inflation, including raising interest rates and cutting back their asset purchasing programmes.

If this persists, growth stocks – such as the giant technology companies – should lag as these stocks are generally on higher valuations due to their future earnings prospects. When rates rise, however, these future earnings have a higher discount rate, reducing their appeal.

Similarly, bonds should also perform poorly, as higher interest rates should lead to higher bond yields and therefore lower prices.

Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said it is something investors should brace for heading into next year.

“The snarled up supply chains all over the world that have forced prices higher, don’t look set to ease significantly,” she said.

Guy Foster, chief strategist at Brewin Dolphin, said that production delays will be resolved and supply will catch up with demand, but not until the end of next year.

Until then, prices will continue to climb and central banks will be under increasing pressure to implement tighter monetary policies.

Inflation rates are currently well above central banks’ aims of 2%, leading to fears that increasing prices may lead to a mismanagement of monetary policy.

Streeter warned that the balancing act of combating inflation with stimulus programmes while ensuring economic growth, “may keep a lid on valuations, squeezing exuberance out of the markets”.

However, banks risk ‘stagflation’ if they do not act, according to Ben Russon and Will Bradwell, fund managers at Franklin Templeton. This could occur in some markets next year if inflation rates exceed GDP growth.

Central banks have already started to act, but differ on their approaches. Below, Trustnet looks at how the three main central banks are tackling inflation in their regions in 2022.

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Bank of England

The Bank of England (BoE) rose interest rates to 0.25% after inflation rose to 5.1% in November, the highest it has reached in 10 years.

Changes to monetary policy are a rarity for the BofE, which has barely altered interest rates for much of the past decade, but the current inflation situation became too big to ignore.

David Roberts, head of the global fixed income team at Liontrust, said: “With RPI running at 7%, unemployment falling fast and fears that further lockdowns would only fuel further price rises, delaying rate hikes would surely have been a mistake.”

The bank has had to rethink its outlook after its original prediction that inflation would not reach 5% until spring next year was quickly shattered. New estimates anticipate that inflation in the UK will peak at 6% in April before easing.

However the loaming threat of Omicron and stricter covid restrictions on the horizon could fast forward inflation again, leading to additional monetary tightening in the new year.

Slow GDP growth, which rose just 0.1% in November, made the bank hesitant to raise interest rates and stifle an already struggling economy. With a potential lockdown inbound, economic growth may slow down to the backdrop of rising inflation.

Laura Suter, head of personal finance at AJ Bell, said: “While Omicron is still a worry for the Bank, rampant inflation is clearly an even bigger concern.”

Federal Reserve

The US Federal Reserve (Fed) has taken one of the most aggressive strategies to combat inflation by tapering its bond purchasing programme.

The bank announced that it would be doubling its monthly tapering to $30bn (£22.5bn) after inflation in the US reached 6.8% in November, its highest level since 1991.

Ellen Gaske, lead economist, G10 economies on the global macroeconomic research team and Robert Tipp, chief investment strategist and head of global bonds at PGIM, said: “Fed officials are nervous inflation dynamics could take hold without more aggressive Fed action.”

After the tapering policy ends in March, Fed officials expect interest rates will be raised three times in 2022.

The Fed aims to reduce inflation rates to 2.6% by the end of next year through these monetary policies, but this may be overly optimistic, according to Kristina Hooper, chief global market strategist at Invesco.

She said: “We do think inflation could remain high — and even rise further — in coming months. However, our base case for 2022 expects the rate of increase to peak by mid-year as supply chain issues resolve, vaccination levels increase and more employees return to the workforce. So in the back half of 2022, we do not expect prices to continue to rise at a quickening pace.”

European Central Bank

The European Central Bank (ECB) also announced that it will be ending its Pandemic Emergency Purchase Plan in March 2021, but offset much of this by doubling the long running Asset Purchase Programme. It also gave no indication of an interest rate rise.

The bank is keeping its monetary policy flexible around the unpredictability of covid, not wanting to slow economic recovery as inflation rises.

Interest rates could potentially rise next year if inflation rates reach 2% ahead of its mid-year predictions, the bank says.

The ECB continues to describe the inflation problem as “transitory”, whereas the UK and US central banks are creating more long-term solutions, albeit with higher domestic inflation levels.

By Tom Aylott

Source: Trustnet

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Pound / Euro Rate Looks to Regain 1.19 after 7% Rally in 2021

The Pound to Euro rate was testing the waters above 1.19 in the penultimate session of 2021, leaving it within close reach of the year’s highs as Sterling looked to cement a more-than seven percent gain for the period.

Sterling was up 7.4% for 2021 as the Pound-to-Euro exchange rate sought to reclaim the 1.19 handle on Thursday following a break above technical resistance near 1.1870 during holiday-shortened trading earlier this week.

This last minute advance placed Sterling on course for an eighth consecutive daily increase against the single currency and positions the Pound-to-Euro rate within arm’s reach of 2021 highs at 1.1931, which were established before late November’s emergence of the Omicron strain of coronavirus.

“Markets remain well-convinced that the BoE will lift its policy rate again at its earlyFebruary meeting, assigning an ~85% chance of a hike with another increase at its May decision fully priced in,” says Shaun Osborne, chief FX strategist at Scotiabank.

“We see the EURGBP deepening its decline from 0.86 earlier this month to a firm break under 0.84 [GBP/EUR above 1.1904] as the BoE is brought to action given steepening inflation and the ECB stands back,” Osborne and colleagues said of their 2022 outlook in a Wednesday market commentary.

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The Pound-Euro rate would potentially have scope to test the 1.20 level and multi-year long layer of technical resistance on the charts early in the new year should year-end trading facilitate a recovery above 1.19.

“The Pound has been feeling better about improved economic data and less concerning news around the dangers of the omicron variant. This has resulted in upwardly revised BOE rate hike expectations as the market gets back to focusing on the economy and the uptick in inflation,” says Joel Kruger, chief FX strategist at LMAX Exchange Group.

“Trading conditions will be thin from now through the second week in January, with so many off the desks for holidays,” Kruger also said on Wednesday.

The Pound-to-Euro rate’s late December advance has been driven most recently by a rally in GBP/USD, which reversed nearly half its decline from 1.39 in September to 1.3163 by late November during the final trading sessions of the year.

Sterling’s year-end rally was ignited earlier in December when official data showed inflation topping 5% for November and employment going unaffected by September’s end of the HM Treasury furlough scheme.

This ultimately triggered December’s Bank of England (BoE) decision to lift Bank Rate to 0.25%, which came as a surprise to the market and marks the first in a likely series of steps to reverse the interest rate cuts announced at the onset of the pandemic in 2020.

“With the pound on the rise today, we can see that higher Omicron cases may not necessarily result in the outlook for sterling losing traction,” says Joshua Mahony, a senior market analysts at online trading firm IG.

“Instead, traders can focus on the fact that the Bank of England decided to raise rates in the face of rising Omicron cases, with a strong chance that the UK will find itself with better herd immunity and an improving economic outlook by the February BoE meeting,” Mahony said on Thursday.

Written by James Skinner

Source: Pound Sterling Live

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Challenges mounting for the UK economy

Despite a successful vaccination programme and a post-lockdown boom, what challenges await the UK economy in 2022?

The UK’s successful vaccination programme and subsequent re-opening boost led us to hold an overweight in UK equities for much of the year. But challenges are now mounting for the UK economy and we moved to an underweight position in mid-September, reflecting the more cautious approach to risk in the portfolio as a whole.

Things were looking good for the UK economy in the Spring of 2021. The UK underwent one of the strongest vaccine-led recoveries in developed markets. Services PMIs moved comfortably into expansion territory as economic activity came back online in many sectors that had been effectively shut down because of lockdown restrictions. In addition, UK equities were trading at a discount to the richer valuations in other developed markets, largely due worries about the ongoing impact of Brexit. As the year progressed, the preference towards the UK proved rewarding as UK equities gained strongly over the YTD period.

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A year of two halves

However, that re-opening boost is now firmly in the past and the UK economy now faces several challenges that have led us to reduce our exposure. First, inflation is becoming a major headache for the Bank of England. The current bout of price rises is in part due to pandemic-related bottlenecks. However, unlike the Federal Reserve and the ECB, the Bank of England still views its 2% inflation target as an upper limit rather than an average, and therefore feels duty-bound to act sooner to curb inflation. The recent guidance from the Bank of England has directed markets to expect a rate hike soon. However, we feel this would likely be a mistake given the weakness now showing in the UK’s economic growth.

Second, Covid-19 cases are once again rising in the UK, with hospitalisations and deaths now at their highest levels since March. Even though the government may not act to re-introduce official restrictions, people may choose to avoid activities with a higher likelihood of transmission anyway if they feel unsafe. Recent news of another virus mutation potentially more transmissible than the Delta variant only serves to underscore how fast the narrative could change for the worse.

Third, September marked the end of the furlough scheme that subsidised the wages of workers that would have been laid off due to the pandemic. Data on the impact that this will have on the jobs market is still coming in, but the transition adds additional uncertainty to the labour market. The effects of Covid-19 coupled with Brexit has led to a well-publicised acute shortage of workers in a number of roles, such as HGV drivers.

Hospitality too has experienced a shortage of workers, while at the same time trying to meet the increased demand associated with the economic re-opening. This is something I can attest to anecdotally, having recently been out marketing around the UK. A recurring theme in the hotels and restaurants I have visited is one of not enough staff to fill vacancies resulting in not all facilities being available. These staff shortages are having a knock-on effect on business and growth.

Lastly, the recent surge in energy prices in the UK is a serious concern. The UK use a relatively large proportion of natural gas to generate its electricity, and is more exposed to the extreme price moves. While the most obvious impact is higher inflation, we believe that markets are underestimating the potential hit to growth in both the UK and Europe, particularly if the winter is colder than usual and gas supply constraints do not improve.

What now?

As a result of the worsening outlook for the UK, we have lowered the exposure to the UK in the Open range. This mirrors our more cautious view of risk in general, having also moved to underweight equities overall. Global growth is slowing, inflation is a concern in many developed markets, and the fallout from China’s shift in direction of policy could yet spread to other markets. We have increased our cash position, especially in light of the inflation concerns weighing over government bonds, and have increased holdings of defensive equities such as utilities to add protection in the event of a market correction.

By Chris Forgan

Source: Money Marketing

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