Pound / Euro Relief Rally, Hopes for Breakthrough in Ukraine War Negotiations

• GBP puts in strong performance
• Ukraine fades as a concern for markets
• Allows GBP's 'beta' to shine
• But GBP bulls remain in short supply

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The British Pound extends a recovery against the Euro and Dollar amidst an improved global market sentiment, with renewed hopes for a diplomatic breakthrough to the war in Ukraine providing investors some cheer.

Sterling was amongst the best performing major currencies on March 22 when newswires reported the potential for a breakthrough in ongoing peace negotiations between Russia and Ukraine, and improved sentiment could offer further near-term advances for the currency.

A meeting between the Ukrainian and Russian presidents will be possible after a draft roadmap toward a settlement is prepared so that they can discuss it, said a leading official in the Ukrainian government.

Mykhailo Podolyak, advisor to the Ukrainian presidential office chief, said on Telegram on Tuesday that both sides continue to work on the outline of a deal that could be presented to leaders ahead of a final agreement.

"When the working groups draw up some preliminary documents within the framework of the negotiating process and these are passed on to the presidents, they will evaluate whether this is a roadmap that could be discussed tete-a-tete. Then such a meeting could take place," Podolyak said.

"Any substantial decisions can be made only at a meeting between the presidents of the two countries," he added. "The negotiations are ongoing in an online format all the time, and there are a lot of consultative groups involved in this process."

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• High street bank rates (indicative): 1.1610 - 1.1694
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The war in Ukraine is 28 days old today and with little new material developments it appears the markets have to a degree fully digested the implications of the current equilibrium.

This equilibrium accounts for the slow and chaotic advance of Russian forces, the brutal destruction of Ukrainian towns and signs the majority of market-relevant Western sanctions have now been passed against Russia.

"The focus on the Russia / Ukraine military conflict becomes marginally less frantic and all-encompassing," says Shahab Jalinoos, Global Head of FX Strategy at Credit Suisse.

This easing of concerns allows the Pound's 'beta' to shine, i.e. when global assets that perform well during times of improved sentiment are gaining, so too is the Pound.

"Sterling’s relatively high cyclical beta should dominate these factors to some extent, and - short of further escalation risk - GBP/USD can continue to unwind the risk premium that has been built over recent weeks," says analyst Zach Pandl in a weekly currency research briefing.

The Pound to Euro exchange rate rallied to a high of 1.2035 on Tuesday, which places it towards the top of its 2022 range and should sentiment hold steady further gains are possible.

But the market has thus far proven resistant to maintain levels above 1.20 for GBP/EUR for any meaningful period of time and the prospect of a reversion lower increases the further beyond 1.20 the pair travels.

Above: GBP/EUR four-hour chart shows the resistance faced by Sterling sellers above 1.20.

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The Pound has proven to be one of the major laggards during the war but so too has the Euro, which is also likely to react to headlines coming out of Ukraine.

One analyst we follow finds the Eurozone is particularly vulnerable to energy price dynamics given its dependency on Russian gas and oil exports.

"In the near term, we expect the GBP to outperform its European G10 FX peers but underperform G10 commodity currencies," says Eimear Daly, FX and EM Macro Strategist at Barclays.

For Barclays, energy dependency is an important factor to consider when assessing the outlook for G10 currencies within the context of the Ukraine war.

"Among the G10 energy importers, the UK is the most energy self-sufficient. It produces 71% of its primary energy consumption needs, compared with only 21%
for the eurozone," says Daly.

Daly says over 80% of the UK’s natural gas imports come from Norway, with only 15%
from Russia.

"While the UK will still be affected by the energy price shock, it does not face the same magnitude as its European peers," she adds.

Above: GBP/EUR one-month chart shows GBP/EUR is looking to break higher out of a long-term range located below 1.20.

Barclays anticipate the Pound to remain supported through to year-end, helped by strong economic growth momentum and a central bank hiking cycle.

The Pound fell in the wake of the Bank of England's decision to hike rates by 25 basis points on Thursday 17 March, with some economists pointing out the Bank was becoming increasingly concerned for the outlook of UK economic growth.

The market anticipates just over 100 basis points worth of hikes to be delivered by the Bank for the remainder of 2022, which is at odds with what the Bank is communicating is necessary.

Currency analysts say any recalibration lower in market expectations for future rate hikes remains one of the key risks to the Pound's outlook.

"OIS pricing is back to expecting a Bank Rate above 2% at the end of this year with ~140bps in hikes projected. This implied policy rate is about 65bps higher than where BoE communications suggest it will be at the December meeting, and we think it will be tough for the GBP to gain ground," says analyst Shaun Osborne at Scotiabank.

Pound Sterling Live has access to a considerable amount of institutional research and we note it remains difficult to find any GBP bulls in the analyst community, with most continuing to expect the currency to turn lower over coming months.

If they are correct the Pound won't have much further upside to offer.

"We think that UK rate hikes will not provide a boost to GBP," says Kamal Sharma, FX Strategist at Bank of America. "Simply put, the Bank of England is hiking in our view, for the wrong reasons and sounding defensive."