Pound Sterling Suffers on Market Slump Linked to Global Covid Surge, Euro and Dollar Benefit

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A souring of global investor sentiment linked to surging global Covid-19 cases has contributed to a decline in the value of Pound Sterling against the Euro and Dollar, confirming that the UK currency will need a supportive global investment backdrop if it is to advance in value.

The Pound had been flying high as the new week commenced, but a sudden turn of fortunes heading into the mid-week session will serve as a reminder that a confluence of drivers hold sway over the currency and volatility is never far off.

The Pound is considered by analysts to be a pro-cyclical currency, i.e. one that benefits when the global economy is rising and investor sentiment is positive; therefore episodes of stock market decline can often be mirrored by a decline in the Pound.

Above: The FTSE 100 and GBP/USD have risen in tandem during 2021 and both fell amidst market selling on April 20.

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While fundamental UK drivers are largely supportive of the Pound, the global picture will often at times trump these domestic concerns.

One only needs to look at the Pound's performance during the Global Financial Crisis - when it hit an all-time low against the Euro - and during the onset of the Covid-19 crisis in early 2020 for a reminder of just how susceptible it can be to market declines.

"European markets have been hit hard," says Joshua Mahony, Senior Market Analyst at IG. "Rising global coronavirus cases serving as a timely reminder that the pandemic is far from over despite recent vaccination progress."

The FTSE 100 index fell by over 2.0% at one point on Tuesday, Germany's DAX fell by 1.57% and the S&P 500 lost 1.0%.

In tandem, the Pound-to-Dollar exchange rate (GBP/USD) fell over a third of a percent to quote a 24-hour low of 1.3933; the Pound-to-Euro exchange rate fell by a third of a percent to quote a 24-hour low of 1.1567.

"Risk appetite has been under pressure the last 24 hours among other things as the number of Covid-19 infections rise, especially in Asia. The WHO said that the number of cases are rising in all regions except Europe," says Arne Lohmann Rasmussen, Chief Analyst at Danske Bank.

Infections are soaring in India and hospitals there are on the brink of collapse, while in Japan, Tokyo and Osaka have asked the government to declare a state of emergency from April 29 to May 9 and introduce stricter restrictions to contain the virus ahead of the Olympics in three months' time. 

"EUR/GBP moved slightly higher yesterday amid general risk-off, illustrating that GBP is still vulnerable when market sentiment deteriorates," says Rasmussen.

The U.S. Dollar, which had been aggressively sold at the start of the new week flipped its fortunes to outperform all of its G10 peers as investors liquidated exposure to stocks and other risky assets, creating a bid for the U.S. currency.

The move serves as a reminder that the Dollar continues to possess safe-haven credentials that will see it bid when investor confidence suffers a knock.

The Dollar has struggled in April and is in fact the month's worst performer on a combination of softening ten-year U.S. treasury yields and risk-on sentiment.

"While the reversal of US dollar strength is notable, we are cautious over how much further this US dollar sell-off can go. We remain bearish over the medium to long-term but remain aware of the still elevated COVID infection rates," says Derek Halpenny, Head of Research, Global Markets EMEA and International Securities at MUFG.

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The Euro was meanwhile also a beneficiary, advancing against most of its peer group apart from the ultra-safe haven Yen, Franc and Dollar.

How the currency market evolves over the remainder of the week could therefore ultimately depend on whether or not investor confidence makes a return.

Foreign exchange analysts at Bank of America retain a constructive view on the Pound, provided the broader market backdrop remains supportive.

"In broad terms, a pro-cyclical, risk-on environment should be GBP supportive as it will for other high beta currencies. What will see GBP standout is whether the UK can continue to attract investment inflows, which have been a hallmark of the recent appreciation," says Kamal Sharma, G10 FX Strategist at Bank of America.

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GBP/USD had earlier in the week risen to 1.40 while the GBP/EUR hit 1.16 once more, offering some welcome strength to those looking to exchange out of Sterling.

Confidence in the Pound has improved since the signing of the EU-UK trade deal in December, with demand for protection against a decline in the value of the currency falling to a new post-Brexit trade deal low on Tuesday, according to Thomson Reuters data.

Data shows the premium for buying protection against declines in Sterling has fallen to its lowest level since late 2020, when the cost of such protection soared ahead of the signing of the EU and UK trade deal.

The developments in options markets - where businesses, institutions and investors hedge their currency market exposure - suggests an easing in the cost of insuring against volatility in Sterling.

The easing in demand for downside hedges reflects an ebbing belief in the market that destabilising and unexpected declines are likely.