British Pound Bid Amidst Market Recovery

- GBP finds support amidst market recovery
- China announces exit from strict quarantine measures
- GBP to remain vulnerable to any further deterioration in sentiment
- UK headed for deep recession according to PMI data

Image © Adobe Images

- Spot GBP/EUR rate at time of writing: 1.10827
- Bank transfer rates (indicative): 1.0548-1.0624
- FX specialist rates (indicative): 1.0900-1.0930 >> More information

- Spot GBP/USD rate at time of writing: 1.1786
- Bank transfer rates (indicative): 1.1473-1.1556
- FX specialist rates (indicative): 1.1610-1.1680 >> More information

Pound Sterling was seen trading with a firmer tone on Tuesday, March 24 in line with a broader recovery in global investor sentiment, but we believe it remains too soon to call a turn in the currency's fortunes which would require a further stabilisation of investor sentiment with regards to the coronavirus pandemic.

The current improvement in sentiment was reflected in a broad-based recovery in the world's major stock markets, which was in turn driven by some much-needed positive developments concerning the global coronavirus pandemic.

As Western economies enter stricter lockdown phases to counter the spread of the coronavirus, news that China will lift travel bans in Hubei province from Wednesday serves as a rare pice of good news for markets and prompted investors to buy discounted stocks and other 'risk-on' assets.

China was first to shut down owing to the spread of the virus and now appears to be the first country emerging out of the crisis.

This is a constructive development for those currencies that are most exposed to the performance of the Chinese economy, particularly the Australia Dollar and New Zealand Dollar while it also aids a recovery in overall investor sentiment generally.

However, the British Pound also sits on this spectrum, falling when stock markets are in decline and rising when they are moving higher as the UK currency is particularly prone to shifts in the inflows and outflows from the UK of investor capitall.

Stock markets rallied on the news that the easing of restrictions by Chinese authorities comes after Hubei province reported new infections dropped to zero on March 19, suggesting the spread of the disease had all but been contained.

While there are some cases of new infections, it is believed these are in citizens returning to China from other parts of the world where they would have been exposed to the virus.

Authorities have added they will lift restrictions on citizens in the town of Wuhan - the epicentre of the global virus pandemic - from April 8.

China initiated a strict lockdown in Wuhan and Hubei province on January 23, thereby restricting the movements of 60 million people and setting the Chinese economy on the path to a sharp economic slowdown that translated into significant falls for 'risk-on' currencies such as Sterling.

The FTSE 100 is trading 4.5% higher at the time of writing, the German DAX is up 6.6% and France's CAC is up 5.8%. The strong recovery in Asia and Europe looks set to feed into the U.S. session where futures for the Dow and S&P 500 are aimed higher.

Pound Sterling has responded to the developments by going higher: the Pound-to-Euro exchange rate is trading 0.70% higher at 1.0843, a sharp reversal of the poor performance seen at the start of the week.

Above: Sterling-Euro's daily chart puts the scale of the recent declines into perspective when compared to today's bounce.

The Pound-to-Dollar exchange rate is up 1.51% higher at 1.1766, having been as low as 1.1401 earlier in the month.

If Sterling can solidify today's gains we well could be close to considering that a temporary floor has been found.

However, Sterling remains vulnerable to any further episodes of investor fright and flight owing to the UK's persistent current account deficit. The UK imports more than it exports - typically we would expect the exchange rate to move lower until an equilibrium is reached between the two. However, in times of investor optimism the UK tends to attract vast quantities of international capital, which in turn bids Sterling higher.

When a crisis comes along, this inflow of capital declines and even reverses, as was the case in the financial crisis of 2008 and is the case now in the coronavirus crisis.

"The UK has a twin deficit with the biggest current account deficit (as % of GDP) in G10. A constant capital inflow is therefore needed to underpin the GBP which is challenging in the present 'dash for cash situation'," says Morden Lund, US & UK analyst at Nordea Markets.

We expect the Pound to remain exposed to broader risk sentiment and would therefore expect it to carve out a base and start recovering provided markets believe they can see the end of the crisis on the horizon.

However, any unforeseen setbacks - and there have been many - could well see Sterling revert to is March trend of depreciation.

Deep Recession Looms

Sterling's recovery comes as the UK economy suffered a sharp decline in activity in March, according to the first tangible set of economic data covering the advent of the coronavirus crisis.

According to IHS Markit, March data highlight that the coronavirus outbreak has "already dealt the UK economy a more severe blow than at any time since comparable figures were first available over 20 years ago".

The Flash UK Composite Output Index - which gives a combined reading for the services and manufacturing sectors - for March read at 37.1, this is down from February's 53.0 and is a survey record low..

Any reading below 50 signifies decline.

The Flash UK Services Business Activity Index for March read at 35.7, down from February's 53.2 and is once more a record low for the survey. This is significant as the services sector accounts for over 80% of UK activity.

The latest IHS Markit/ CIPS Flash UK Composite PMI was compiled between 12-20 March 2020 and we expect an even deeper contraction to be reflected in the Final PMI figures which would cover the lockdown announced by the Government on March 23. The Government closed schools, restaurants, bars and gyms on March 20, and announced the closure of non-essential shops and introduced a lockdown on movement on March 23.

"The first conventional data for March confirmed that the coronavirus was having a massive negative impact on activity even before the Government introduced significant measures to slow the spread of the virus," says Andrew Wishart, UK Economist at Capital Economics.

The Flash UK Manufacturing Output Index meanwhile fell from 52.2 in February to 44.3 in March, which is a 92-month low.

“The surveys highlight how the COVID-19 outbreak has already dealt the UK economy an initial blow even greater than that seen at the height of the global financial crisis. With additional measures to contain the spread of the virus set to further paralyse large parts of the economy in coming months, such as business closures and potential lockdowns, a recession of a scale we have not seen in modern history is looking increasingly likely," says Chris Williamson, Chief Business Economist at IHS Markit.

IHS Markit research shows the March survey reading is consistent with GDP falling at a quarterly rate of 1.5-2.0%, a decline which is sufficiently large to push the economy into a contraction in the first quarter.

While such data would typically be bad for Sterling, it must be remembered that the same figures are being seen across the world's major economies. Therefore, on a relative basis the data doesn't offer much by way of guidance for currency markets.