The British Pound leapt in value against all its major peers on Tuesday, banking gains that come in sympathy with an ongoing move higher in global equity markets which provide the supportive sentiment backdrop within which the Pound traditionally appreciates.
Adding to this is an expectation that the Bank of England could raise interest rates as soon as November 04, putting it months, if not years, ahead of the European Central Bank (ECB) in this regard. However advances against the Dollar remain shallow, given the U.S. Federal Reserve is on target to raise interest rates in 2022 with the November policy meeting likely to provide confirmation of this.
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Confidence for a rate hike at the Bank will have been bolstered by recent signs UK Covid-19 cases are turning lower once more, suggesting the coming winter months might not be as difficult as many had feared, opening up the potential for a robust rebound in economic activity into year-end.
“The British pound hit a new 2021 high versus the euro this morning. In fact, it’s the highest level since the pandemic-induced market turmoil in March 2020. UK bond yields continue to surge with the 10-year yield above 29-month highs, boosting GBP demand, particularly against low-yielding currencies like EUR,” says George Vessey at Western Union Business Solutions.
Pound to Euro exchange rate has reached a new 2021 high after it hit 1.1898 on October 26, the Pound to Dollar exchange rate meanwhile pushed above 1.38 again to quote at 1.3820.
“Pound crosses are continuing to shine brightly today as investors increase their expectations over an imminent interest rate hike in the UK,” says Fawad Razaqzada, Market Analyst at ThinkMarkets.com
Bank of England Governor Andrew Bailey said last week the Bank “will have to act” to keep a lid on inflationary pressures and the markets now expect a 15 basis point interest rate rise to be delivered on November 04.
The risk to the Pound’s recent gains is that this is not in fact delivered and the Bank strikes a more cautious tone on the outlook, in an attempt to pare market expectations for further rate hikes in 2022.
This pushback is expected by numerous analysts we follow: most recently NatWest Markets said they are exiting their long-held bet for Pound-Euro upside saying there is a risk the Bank of England strikes a more subdued tone next week.
“Only a hawkish statement by the Bank of England suggesting a faster sequence of hikes than the market currently expects might support the pound, but this is not something we are expecting,” says Thomas Flurry, a strategist at UBS.
The Euro does however meanwhile appear to be under pressure ahead of Thursday’s European Central Bank (ECB) meeting, where policy makers are expected to push back against market expectations for a 2021 rate rise.
Jeremy Thomson-Cook, Chief Economist at Equals Money, says the ECB meeting on Thursday is “set to offer” Euro weakness.
“We are very much expecting “more of the same” from the European Central Bank on Thursday. There is no way that they can’t acknowledge that inflation has run higher but also they do not want to get dragged into a game of expectations, given the ECB’s dovish proclivities,” says Thomson-Cook.
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Investors will find the October ECB policy meeting more interesting than normal as President Christine Lagarde is expected to fight the market’s expectation that 2024 is too late for a first rate rise.
Euro exchange rates could therefore prove volatile, reacting to Lagarde’s performance.
Market pricing that now shows investors anticipate the first ECB rate rise to fall as early as late-2022 as policy makers are forced to react to rising inflation levels.
Money markets currently expect a rate rises of close to 10bp in a year and more than 30bp in two years.
This expectation has contributed to higher financing levels in the Eurozone over recent weeks, which the ECB is keen to avoid.
Indeed, the ECB are clear that a more appropriate time for such a move would be in 2024, viewing the spike in inflation as a strictly temporary phenomenon.
“We expect the ECB President to argue that the current acceleration of inflation will not persist,” says Silvia Ardagna, an economist at Barclays.
Barclays expect the ECB to talk down current market pricing, “extinguishing any hope of narrowing rate differentials to support the euro higher”.
If the Euro has found support from a recalibration in market expectations it stands that it could weaken if the ECB strikes a convincingly ‘dovish’ tone.
However, if at least some of these expectations persist following the meeting then the Euro could rally.
“We think the ECB will continue to favour extended monetary accommodation, with policy rates at current levels for longer than currently priced and a large and flexible QE programme in 2022,” says Ardagna.
Research from Nordea Bank shows that core inflation is only really likely to reach the ECB’s target levels (2.0% and above) in 2023, which would be more or less consistent with the ECB’s current guidelines.
This should provide the ECB the ammunition to push back the market’s recent unwelcome pricing.
Anders Svendsen, Chief Analyst at Nordea, finds Eurozone headline inflation will peak in the coming months but is then expected to decline substantially in the winter months when Nord Stream 2 starts to operate, easing the pressure on energy prices.
“The higher inflation expectations, which are now prevailing in the financial markets but have also gathered pace among companies and consumers, have the potential to lift nominal wage growth and hence make inflation more likely to remain around the inflation target in a kind of “positive” second-round effect,” says Svendsen.
How the ECB acts in contrast to other central banks matters for currency moves.
“A largely status quo ECB stands in contrast with global central banks looking to normalise,” says Marek Raczko, a strategist at Barclays.
The Bank of England is one such central bank that has signalled a clear intention to act sooner rather than later on normalising rates, fearing that the current surge in inflation caused by rising fuel prices and supply constraints could become embedded elsewhere in the economy.
“EUR/GBP was falling even before interest rates moved in favor of the UK. This likely reflects ongoing euro-area weakness, where energy concerns and China growth challenges have hit the region and hence the currency. Regardless, the combination of these forces has set up the possibility that EUR/GBP could plumb new post-Brexit vote lows,” says a strategy report from CME Group released on October 26.
Written by Gary Howes
Source: PSL