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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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BoE provides further support for interest rate hike

Ben Broadbent, the monetary policy chief for The Bank of England has said that inflation is likely to soar above 5% in the first half of next year. With forecasts comfortably above the BoE’s 2% inflation target, it is expected that interest rates will be hiked early in 2022. Despite the positive sentiment, GBP has found little support amongst its piers, continuing its downward trend against USD and struggling to break out of the 1.17 channel against EUR. Broadbent has indicated the Bank of England believes this accelerated inflation in the cost of goods has come as a result of short-term global supply chain squeeze and is likely to reverse slightly into next year as conditions improve.

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Some analysts and market makers are suffering from what could be coined interest rate “cold feet”. Market expectations have changed dramatically over the past 6 months, with forecasts placing a hike before the end of the year now being shunted towards the back end of Q1 2022. These continual shifts can create a “boy who cried wolf” scenario, producing a difficult landscape for GBP to find it’s much needed support. COVID-19 uncertainty is also playing a part – the rise of the new Omicron variant can put a dampener on economic policy change, with the UK Government needing fully understand the potential fallout prior to committing to a hike.


Source: World First

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Pound Sterling Recovery against Euro and Dollar Can Hold: Analysts

The British Pound is tipped by a number of institutional analysts to remain supported and over time extend higher from the lows it plumbed against the Euro and U.S. Dollar just last week.

The Pound has at the time of writing clawed its way back up into the familiar multi-week ranges it had established against the Euro and Dollar in the April-September period, having briefly slumped to multi-month lows against its two major peers.

“Adverse headlines on various shortages in the UK hit sterling, but we expect a recovery in investor sentiment toward the pound with the Bank of England clearly heading toward tightening next year,” says Gaétan Peroux, Strategist at UBS AG.

The Pound-to-Euro exchange rate has crossed the 1.17 level again while then Pound-to-Dollar exchange rate sits just below 1.36, but Friday’s U.S. jobs report will almost certainly prove the highlight of the week for this pair.

The British Pound was sold heavily against the Euro and Dollar in the previous week alongside global stocks and high yielding assets as investors fretted that inflation was headed higher for a protracted period amidst a global energy crisis.

But the Pound was easily the worst performing of the world’s major currencies by the mid-week session, suggesting there were some UK-specific factors bothering investors and this was not simply a typical ‘high beta’ event for the currency.

A surge in UK gas prices to record highs combined with a run on fuel station forecourts by panicked consumers pointed to a combination of weakening growth and the potential for materially higher inflation; a potently negative cocktail for the economy.

Sterling was nevertheless able to stage a notable recovery into October 01, probably helped the completion of month-end and quarter-end repositioning on global markets.

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“The GBP is probably overreacting to the deepening of the energy and fuel crisis in the UK, and this is overshadowing the hawkish turn the BoE made just last week,” says Roberto Mialich, FX Strategist at UniCredit.

Helping the Pound lift off from its previous week’s lows was the Thursday release of UK GDP data that showed the economy grew more than had been previously assumed during the second quarter.

In fact, such was the scale of the upgrade economists now say the UK economy’s performance is now comparable to those of other G7 countries.

The UK suffered a deeper contraction than many of its peers during the Covid crisis owing to an economy that is heavily reliant on the services sector, but the scale of the rebound means it has recaptured that lost growth.

GDP growth for the second quarter read at 5.5%, higher than the original estimate for growth of 4.8%.

This means the UK’s level of GDP is now 3.3% below where it was pre-pandemic in the fourth quarter of 2019, revised from the previous estimate of 4.4% below.

The developments mean the Bank of England is likely to raise interest rates in early 2022, which is sooner than other other major central banks such as the Federal Reserve and the European Central Bank.

This rates advantage is said by analysts to be a fundamental source of support for Sterling.

“We also continue to believe UK’s attractive investment attributes and longer-term GBP undervaluation will act as a strong anchor for the pound,” says Marek Raczko, a foreign exchange strategist at Barclays.

Economists at Barclays now see 2021 growth at 7.3% having upgraded it 0.9pp following the GDP release. Under their new profile, the UK economy recovers to its pre-pandemic level in the first quarter of 2022, a quarter earlier than previously forecast.

“We expect markets to focus on longer-term fundamentals as a guide for GBP’s trajectory. Last week’s GBP weakness felt at odds with the aggressive repricing higher in UK yields (three hikes priced next year),” says Raczko. “Longer-term GBP undervaluation will act as a strong anchor for the pound.”

UBS strategists say they maintain a clear case for a Sterling rebound against other major G10 currencies in the short term, including the dollar.

They also anticipate continued gains against the euro and the Swiss franc in the medium-to-long term, supported by faster Bank of England tightening via the ending of quantitative easing in December and the raising of interest rates.

“The month of September was punctuated with a change in narrative from both the Bank of England and the Fed – both central bank meetings were interpreted as more hawkish than the market was expecting and as such both short-term and long-term interest rates have jumped higher,” says Shane O’Neill, Head of Interest Rate Trading for Validus Risk Management.

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“GBP rates have moved the most, 10y yields printed over 1% for the first time since the middle of 2019. Inflation expectations continue to dominate the narrative here and look set to be the market driver as we head into Autumn,” says O’Neill.

Should investors remain focussed on the UK rate advantage then the prospect of the Pound extending higher remains alive.

The major headwind for the Pound at this stage is the broader market environment which remains vulnerable to weakness.

The Pound has a ‘high beta’ when compared to the Euro, Dollar, Franc and Yen, meaning it tends to fall against these currencies when global stock markets are falling.

Global markets are now well off their 2021 highs amidst a cocktail of concerns that global growth is slowing, inflation will stay stubbornly high, supply chains will remain choked up and central banks will be boxed into raising interest rates.

So often during the post-pandemic stock market boom the Federal Reserve would reassure investors that it stood ready to keep cheap finance flowing to the U.S. and global economies whenever sentiment deteriorated, but this is no longer the case given the high inflationary environment.

In fact, the risk is that the continuation of quantitative easing and crisis-era rock-bottom interest rates will only fuel inflation.

Global markets are undergoing a readjustment and this creates risks for the Pound against the ‘safe havens’ such as the Dollar, Yen, Euro and Franc but it does offer potential upside against the likes of the Australian and New Zealand Dollars as well as Emerging Market currencies.

“We think that a return to a regime of higher and less stable inflation in many major economies would result in a rise in exchange rate volatility and, over time, the depreciation of the currencies of those countries which experience higher inflation,” says Jonas Goltermann, Senior Markets Economist at Capital Economics.

Goltermann says over longer time horizons countries with relatively high inflation tend to experience depreciation of their nominal exchange rates.

“Among developed economies, we think the US, as well as the UK, Canada, and Australia, are more at risk of sustained higher inflation. This suggests to us that their currencies will weaken in nominal terms relative to the currencies of many European and Asia economies, where we expect inflation to remain subdued,” says Goltermann.

Written by Gary Howes

Source: Pound Sterling Live

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Pound Sterling Losing Shine against the Euro, a Sell Against Dollar says Nomura

“Is GBP losing its shine?” queries Jordan Rochester, Global FX Strategist for Nomura in a new research note on the UK currency that comes as we move into the new month.

“We argue yes,” is his the answer.

Rochester joins other economists in noting the UK economy’s growth rebound to have slowed over recent months and says this dents the bullish stance his team have held on Pound Sterling during much of 2021, particularly against the Euro.

“There are problems popping up ahead in the UK’s macro outlook,” he says.

The list of concerns on the outlook cited by the Nomura analyst includes slowing credit card spending, sideways mobility data, falling data surprises and rising COVID-19 cases amongst the elderly.

The call comes in the same week that IHS Markit’s PMI report for August showed a sharp slowdown in private sector activity in the UK, amidst persistently strong costs facing businesses and staff supply shortages.

The list of headwinds is therefore a long one.

“Data surprises for the UK are falling in a big way and it matters,” says Rochester.

The British Pound rose sharply in the first three months of the year as the hard-hit UK economy exited its winter lockdown.

But the Pound’s gains have since stalled with the Pound-to-Euro exchange rate trending sideways in a loose range below 1.18 but above 1.16. Against the Dollar the recent trend has been lower, with the Pound-to-Dollar exchange rate peaking at 1.42 in June and falling back towards the 1.36 support region.

Nomura are now ‘short’ the Pound against the Dollar in anticipation of a weaker Pound.

But there are however some recent signs that UK consumer sentiment has improved of late, which could yet keep the Pound supported.

Consumer activity has picked up again during August as the UK’s Covid rates pulled back from June highs and settled into an unremarkable trend.

Of note this week was the CBI Distributive Trades survey which showed the retail sector was experiencing a decent rebound in activity in August following a slump in July.

The CBI reported a large jump in the reported sales balance to a six-and-a-half year which will undo a portion of July’s 2.5% month-to-month decline in the official ONS retail sales data.

“With the recent distributive trades survey data suggesting the UK recovery narrative, driven by the consumer, remains in play we remain biased towards looking for EUR/GBP to trade lower,” says Jeremy Stretch, Head of FX Strategy at CIBC Capital Markets.

Pound Sterling Live reported last week that the British Pound could retain support amidst expectations that the recent slowdown in UK economic growth will give way to a stronger late Summer expansion.

A new near-term survey of UK business activity out last week showed that 60% of businesses in the leisure and hospitality sector were projecting a surge in revenue over the August Bank Holiday weekend, with 13% preparing for the busiest Bank Holiday in a decade.

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According to the Barclaycard Payments SME Barometer, confidence among small and medium sized businesses is returning to pre-pandemic levels, with 40% planning to hire additional staff over the next 12 months.

Confidence returned amidst unremarkable Covid-19 case trends and the ending of the restrictive test and trace policy in the middle of August.

How this confidence can sustain itself heading into the Autumn will matter greatly for the Pound’s outlook.

Above: If the UK’s data can start surprising positively, the GBP could be better supported. Image courtesy of Nomura.

Inflation is expected to pick up sharply and approach the Bank of England’s projected 4.0% level which will prove a headwind for consumers, while Covid cases are likely to spike once England’s schools return, as they did in Scotland.

For now expectations are that the bar is set high for the reimposition of Covid restrictions, but the pandemic has had a tendency of throwing up ugly surprises.

“The UK’s COVID-19 situation is not as good as it could be,” says Rochester. “Vaccines have made a big difference, the UK’s restrictions are much more relaxed than they were, but case data are still rising and, most importantly, rising among highly vaccinated, older age groups”.

“We are approaching Autumn with schools set to return (expect a spike in cases from next week), and there are eight times more hospitalisations now compared to a year ago. Vaccine passports, new restrictions and overall lower mobility might be the path ahead. Hopefully that is not the case, but it remains a risk for some time to come,” says Rochester.

When it comes to exchange rates it is critical to remember that relativity is key: the UK economy might be slowing, but there are also signs the same factors impacting the economy are also impacting other countries and regions.

One only needs to look at the rapid economic slowdown in the Asian and Pacific region as countries feel the strain of the Delta variant.

The U.S. is also witnessing a rapid slowdown in activity with the previous week’s PMI survey for August showing private sector expansion slowed sharply in August amidst capacity constraints and Delta variant spread.

Ultimately for exchange rates, how the relative developments impact central bank policy matters.

If the Bank of England sticks with its path towards a 2022 interest rate rise the Pound could remain supported, particularly against the Euro which is burdened by the European Central Bank which is in no mood to even contemplate a rate rise.

The Bank of England will likely raise rates ahead of the ECB courtesy of the UK’s hot inflation levels which they anticipate will reach 4.0% by the time 2021 is done.

How that inflation behaves over the duration of 2022 will be key for the Pound’s longer-term outlook in that expectations for a number of rate rises at the Bank will surely increase if inflation remains stubbornly high.

Higher interest rate expectations reflect in higher yields paid on UK bonds, which tends to translate into support for the Pound.

“We expect UK CPI to double from around 2% towards 4%. Such an increase would be hard for the BOE to ignore and is the main risk to holding short GBP exposure right now. Growth may be slowing, but inflation could cause more hawkish comments from the BOE into year-end,” says Rochester.

While Nomura are looking for Sterling weakness against the Dollar via their short GBP/USD recommendation, they are still fancying the Pound to retain support against the Euro.

Short EUR/GBP (a trade that looks for the Pound to rise against the Euro) still makes sense to Rochester given UK bond yields are likely to remain above Eurozone yields as a result of central bank policy divergence.

“This might be all that matters,” says Rochester.

“However, the problem is that it is a very slow moving trade that has been rangebound for quite some time now. EUR/GBP’s medium- to long-term path is clearly lower, in our view,” he adds.

Written by Gary Howes

Source: Pound Sterling Live

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Sterling sinks to 5-month low as investors seek safety on “Freedom Day”

The British pound hit its lowest since February on Monday as global markets turned cautious over a surge in coronavirus infections, meaning that riskier currencies lost out to the safe-haven dollar.

Risk-aversion ruled the day as bond yields dropped and stocks faced their longest losing streak since the pandemic first hit global markets 18 months ago.

The wary moves coincide with Prime Minister Boris Johnson lifting most COVID-19 restrictions in England in what some have dubbed Freedom Day. Johnson has urged the public to remain cautious as infections in Britain are surging.

Last week, the pound had its worst week in a month versus the dollar. The downward turn continued on Monday with sterling hitting $1.3663 at 1455 GMT, its lowest since Feb. 4.

At 1511 GMT, cable was down 0.6% on the day at $1.36795. Versus the euro, the pound was down 0.6% at 86.3 pence.

Neil Jones, head of FX sales at Mizuho, said that the losses in the pound were caused by investors liquidating their long positions.

“The pound was one of the real darlings of the foreign exchange market for a number of months now,” he said, citing Britain’s speedy vaccine rollout as a driver of gains earlier in the year.

“Since that time there have been developments, some doubts… Market participants would not argue with the success of the vaccine because it has been highly successful but just the variant data does seem to be surging on a global basis.”

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The pound’s status as a risk-sensitive currency means that it faces the potential double whammy of being hurt by rising COVID-19 infections globally, and in the United Kingdom specifically, he added.

Britain has the seventh highest death toll in the world and is forecast to soon have more new infections each day than it did at the height of the second wave of the pandemic. But it is ahead of its European peers in terms of vaccine rollout.

“I think the pound is basically being influenced by general risk appetite as opposed to anything specifically geared towards the UK itself,” said Ned Rumpeltin, head of European currency strategy at TD Securities.

Positioning data showed that speculators’ net long position on the pound – bets that the pound will strengthen – was cut to its smallest since January 2021, in the week to July 13.


Last week, two top Bank of England officials surprised investors by suggesting monetary policy might be tightened sooner than expected.

But BoE interest rate-setter Jonathan Haskel said on Monday reducing stimulus was not the right option for the foreseeable future, despite rising inflation.

By Elizabeth Howcroft

Source: Investing

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The pound retreats after hitting three-year high amid variant concerns

The pound retreated this morning after reaching a fresh three-year high versus the dollar amid economic recovery hopes.

Well into the London session after the bank holiday weekend, sterling reversed its course to fall 0.2 per cent to $1.4183.

The pound edged lower as concerns over a new coronavirus strain outweighed increasing investor optimism on the UK’s economic recovery.

Three-year high

Sterling touched its highest level since April 2018 of $1.4250 during the Asian session against the dollar.

Analysts attributed the rise to positive global investor sentiment towards Britain’s economic recovery.

“Overseas investor sentiment generally is positive towards sterling given the vaccine roll-out and the reopening of the domestic economy,” said Neil Jones, head of FX Sales at Mizuho Bank.

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“The stage is set for the pound to push higher I would suggest.”

Optimism remains high

UK house prices jumped by an annual 10.9 per cent in May, the most in nearly seven years, mortgage lender Nationwide revealed this morning.

Jones said that the house price data, which surprised in the upside, helped to keep optimism around the British currency.

Economic indicators including retail sales and employment measures are also looking up, as well as a deluge of new orders driving a record increase in British manufacturing last month.

Sterling also found support from Bank of England policymaker Gertjan Vlieghe last week, who said the central bank was likely to raise rates only well into next year.

By Damian Shepherd

Source: City AM

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Sterling rises to two-week high against the dollar

Sterling rose to hit a two-week high against the dollar on Monday at the start of a data-heavy week that is expected to provide more evidence that Britain’s economy is rebounding from its deepest recession in 300 years.

The pound had a strong first quarter, supported by dwindling expectations of negative interest rates and by a fast roll-out of vaccinations against COVID-19 across Britain.

As England re-opened shops, hairdressers, gyms and pub gardens in April, analysts expect a faster economic recovery in the United Kingdom than in the European Union, which is facing a third wave of infections.

Traders will be watching PMI surveys for the UK, together with data on the labour market, inflation and retail sales this week.

Both ING and UniCredit analysts told clients there was scope for sterling to strengthen to $1.40 this week.

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“GBP continues to find support on dips and it seems like investors are happy enough staying positioned for the 2Q UK re-opening story,” said Chris Turner, Global Head of Markets at ING.

“Today we have already seen some encouraging April Rightmove house price data,” he said.

Advertised prices for homes in Britain hit a record high after finance minister Rishi Sunak stoked the market again by extending a tax cut for home-buyers last month, property website Rightmove said on Monday.

Speculators’ net long position on the pound versus the dollar rebounded in the week to April 13 after slipping to its lowest since February in the previous week, futures data from CFTC showed.

Versus a weakening dollar, the pound rose 0.4% to $1.3900 at 0958 GMT, its highest level since April 6. It was 0.1% lower versus the euro at 86.61 pence, after it hit its highest of 86.30 pence since April 8.

“Current domestic COVID data is encouraging and a further easing of lockdowns will all point in the direction of the UK economy early out of the block on economic recovery expectations,” said Neil Jones, Head of FX Sales at Mizuho Bank.

Source: ZAWYA

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Pound Sterling Heads for Biggest Weekly Drop against the Euro

The British Pound is on course to record its sharpest weekly decline against the Euro since September 2020, a time when the EU and UK faced a logjam in Brexit trade negotiations that lead markets to raise bets a ‘no deal’ outcome was increasingly likely.

The fall in Sterling in April 2021 however has no clear narrative behind it, although some analysts are pointing a tentative finger at the hiccup in the UK’s vaccination rollout stemming from the UK medical regulator’s decision to restrict the distribution of the country’s ‘workhorse’ AstraZeneca vaccine.

The Pound-to-Euro exchange rate declined by a third of a percent on Thursday to record a five-week low at 1.1540, having been as high as 1.1800 at the start of the week.

The weekly decline is now 1.80% at the time of writing.

Marshall Gittler at BDSwiss says blaming the regulator’s change of guidance on the AstraZeneca vaccine is unconvincing given that the most of the Eurozone’s largest countries have applied similar, if not more restrictive, conditions on the same vaccine.

If anything, news out of the UK on the vaccination front remains positive with official data showing the number of vaccinations delivered on Wednesday exceeded 500K once more, suggesting an Easter drop off is now in the rear-view mirror.

The prospects of the UK exiting restrictive lockdown conditions meanwhile looks all the more certain based on modelling from University College London (UCL), that shows Britain will pass the threshold for herd immunity on Monday 11 April.

If the modelling is correct a resurgence of covid-19 infections and hospitalisations is incredibly remote and businesses and consumers alike can continue investing in a post-covid future, thereby driving a strong economic rebound.

“I think one of the main reasons GBP is falling could be just positioning and trend-following,” says Gittler, “I’m skeptical about this setback”.

“The GBP correction is symptomatic of a market that had become overly positioned at bad levels after a long trend move, positioning finally peaked as many cited the past strong April seasonals… GBP will ultimately regain its poise and drift higher,” says Jonathan Pierce, a trader at Credit Suisse.

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While the Pound went lower by a third of a percent against the Euro on Thursday it is notable that the currency was steady against the Dollar, this was reflected in an Euro-to-Dollar exchange rate that was a third of a percent higher at 1.19.

This suggests the most recent decline in GBP/EUR is more a function of Euro strength than a reboot of the mid-week Sterling weakness.

The rally in the Euro exchange rate complex comes as the EU sees a sharp increase in vaccination rates suggesting the area’s woes concerning vaccinations is coming to an end.

Numerous EU countries, including Germany, recorded a fresh daily record on Wednesday, signalling to markets that a strong vaccine-induced rebound lies ahead.

Pound sterling was a beneficiary through January, February and March of the UK’s rapid vaccine rollout, which contrasted most strikingly with a tepid rollout in the EU.

Signs that this differential with Europe is now closing is therefore offering the Euro fresh support at Sterling’s expense.

We reported on Thursday that research from Citi and Goldman Sachs shows that the Euro stands to benefit as the EU vaccination accelerates in April, allowing foreign exchange markets to focus on a strong Eurozone recovery in the second half of the year.

“We think markets priced much negative Covid news, says Ebrahim Rahbari, Chief G10 Currency Strategist at Citi.

Analysts at NatWest Markets tell clients the second quarter should see significantly higher vaccine supplies from existing producers which include AstraZeneca, Moderna and Pfizer who should together deliver almost three times the amount of doses in the second quarter compared to the first quarter.

This is even after accounting for lower than planned AstraZeneca supply in the second quarter.

“Added to this, Johnson & Johnson vaccinations should begin, with supply reportedly being delivered to European countries from mid-April – this adds an additional 55 million doses to the Q2 total,” says Imogen Bachra, European Rates Strategist at NatWest Markets.

The European Commission now looks on target to vaccinate a minimum 70% of the entire adult population by the end of the summer.

“If we look at the Euro area more broadly, the health situation looks better than the public debate might suggest. Despite the further twists and turns in the AstraZeneca saga, the overall pace of vaccinations is finally starting to surge,” says economist Jan Hatzius at Goldman Sachs.

EU countries are nevertheless grappling with a third wave of covid-19 infections that has prompted the extension of lockdowns in Italy, a fresh lockdown in France and calls by Germany’s Chancellor Angela Merkel for Germany to do the same.

But Goldman Sachs tell clients the virus numbers themselves are not as bad as widely believed, with both positivity rates and fatalities fairly stable despite selective reopening and generally stronger-than-expected economic data.

“Our FX strategists think the end of the recent Euro selloff is near and see a significant appreciation over the next year,” he adds.

Goldman Sachs say it is easy to imagine Europe outperforming their baseline forecasts if Germany and other manufacturing-dependent economies continue to benefit from a strong global industrial rebound, while an earlier-than-expected vaccination breakthrough rescues the Southern European tourist season.

Source: PSL

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The UK government’s Covid spending may lead to inflation

The UK government is spending an enormous amount on COVID-19 – supporting the health service, helping to relieve the suffering of those who have lost their incomes, and helping businesses keep afloat.

This spending policy has now been endorsed by the International Monetary Fund. Governments of advanced economies should spend more, says the IMF, not just to keep their economies in good shape until the pandemic passes, but also to invest in preparation for a post-COVID recovery.

And we should not worry that all this extra spending is causing a big rise in government debt. Although the UK debt/GDP ratio has already risen above 100%, the government should spend even more. This will stimulate GDP growth and thus stabilise debt/GDP.

The way to cope with high government debts, the IMF says, is no longer austerity – higher tax and lower spending – but rather the opposite, at least while the pandemic is with us.

A vital ingredient for the success of this high-spend policy is low interest rates. The UK government’s cost of new borrowing for 10 years is currently 0.3%; it has never been so cheap. The Bank of England is playing an important part in keeping it that way.

How are we paying for it?

To pay for all the extra spending, the government is borrowing in the usual way from the private sector – from pension funds and insurance companies, for instance. It does this by selling bonds, which are promises to pay back with interest. In the period April 2020 to June 2020 it borrowed an extra £150bn. Yet, as fast as the government is selling bonds, the Bank of England is buying them from their private sector holders – paying with newly created money. Technically, this money is “reserve” deposits, which are claims against the Bank of England itself.

Indirectly the Bank of England is therefore financing much of the government’s new spending. And, crucially, its continuing demand for government debt is holding down the interest rate that the government has to pay to borrow.

The Bank of England insists that this massive quantitative easing (QE) programme of bond-buying is not driven by a need to support government finances. Rather, the motive is to fulfil its mandate to control inflation, which has been falling increasingly below the 2% target for over a year. The government’s need for finance and the Bank of England’s bond purchases are both consequences of the recessionary conditions, and it is a coincidence that its purchases of bonds and the government’s sales have been at similar rates.

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You might think that this is splitting hairs, but it matters. If the government can rely on the Bank of England to buy its bonds as necessary to prevent interest rates from rising, then it is hard to be confident that the bank will raise rates enough when needed to stop inflation rising.

And the current low-inflation environment may be short lived.

Inflation may rise

Consumer spending has fallen markedly during 2020. Among the causes, restrictions on several sectors of the economy, notably tourism and leisure, have forced people to save rather than spend. When the restrictions are relaxed, pent-up demand may lead to rising prices, especially if the supply of goods and services is reduced because some businesses have not survived.

On the other hand, some argue that rising unemployment will hold down wages and hence prices, and others expect the recovery to be gradual, giving time for supply to adjust. Moreover, with consumption patterns changing, price changes will vary across sectors, leading to doubt about the overall effect on inflation.

A deeper reason to expect inflation has been proposed in a new book by economists Charles Goodhart and Manoj Pradhan. They argue that the current low-interest rate, low-inflation conditions are associated with a favourable dependency ratio. This measures the numbers of young and old people (0 to 14 and over 65 years of age) relative to those in between who are presumed to be the working population. For the last three decades we have been in a “sweet spot”, they say, with plenty of workers globally to support the non-workers. This has held down wages and led to high saving which, in turn, has contributed to the long-term decline in interest rates.

But the age composition of populations is changing. With people living longer and birth rates declining, the dependency ratio is rising. There are fewer workers and more people who depend on their output; moreover, the old are requiring increasing care. To balance supply and demand, wages and prices must rise.

If inflation starts rising, the Bank of England’s response should be to choke off demand by raising interest rates. However, this will dampen economic growth, which may still be fragile. It will depress the price of assets, including property, and it will make debts more expensive to service, including public and private sector debts, both of which have been elevated by the pandemic. Under the IMF’s projected increase in government debt to 117% of GDP, even a small increase in rates would make this debt significantly harder to sustain.

While the Bank of England is adamant that it will not divert its attention from the 2% inflation target, other central banks are more equivocal. In the United States for example, Jay Powell, the chairman of the Federal Reserve Board, which sets monetary policy, has recently announced that future US inflation will be allowed to exceed its target for a period of time before monetary policy is tightened.

Despite the Bank of England’s insistence, its accommodating behaviour during the Covid crisis suggests that it, too, may take a more flexible attitude towards future inflation.


Source: Reaction

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