Pound Sterling: Returning Momentum against Euro and Dollar

- GBP sees renewed demand
- Yields dynamics favour British Pound - UBS
- "still cautious in the short term" - Nomura

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The British Pound starts the new week just below multi-day highs against the Euro and Dollar amidst a revival of buying interest, which some analysts say could extend over coming days and perhaps weeks.

Upside momentum returns to the UK currency amidst signs that the economy should record strong growth in the third quarter and the Bank of England is on track to raise rates before its European and U.S. counterparts.

"The pound climbed back above the €1.17 and $1.38 handles against the Euro and US Dollar," says Adam Ma, a currency analyst at Western Union Business Solutions. "Should the BoE make a move in early 2022 it would mean the BoE moves sooner than both the ECB and Federal Reserve."

The Pound-to-Euro exchange rate recorded a two-week high at 1.1736 on Friday, a turnaround in fortunes was somewhat unexpected by the analyst community as the pair had hit a seven-week low just two days prior. 

But Sterling eased back ahead of the weekend amidst a global market sell-off linked to renewed concerns over U.S.-China relations, a reminder that global investor sentiment could be a key risk to the nascent recovery.

The Pound-to-Dollar exchange rate meanwhile recorded a new one-week high at 1.3889 before retreating back to 1.1820.

Above: A strong week for the Pound was undermined by a market sell-off late Friday.

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Although the Pound has rediscovered upside momentum investors will want to see improving economic data before turning outright bullish.

GDP data for July surprised when released on Friday as it revealed the UK economy hardly grew at all.

But, economists have looked at the reasons behind the slowdown in growth and ascertain many of them are are now in the past (most notably the restrictive self-isolation rules which ended mid-August).

And expectations for stronger August and September GDP out-turns suggest the third quarter could yet register healthy growth.

The National Institute of Economic and Social Research (NIESR) forecast growth to pick up to 0.7% in August, thanks to the domestic tourism and hospitality industries.

With expected growth of 0.8% in September this would lead to growth of 1.6% in the third quarter overall.

"The return of many office workers, particularly in London, should boost both the transport and hospitality sectors," says Rory Macqueen, Principal Economist at the NIESR.

The Bank of England is meanwhile expected by markets to raise interest rates in the first half of 2022 owing to improved economic growth rates and rising inflation, an expectation widely credited with Sterling's strong performance in the previous week.

Fears that inflation might remain above 2.0% for a protracted period of time is a key concern to the outlook for policy makers and could elicit further interest rate rises than the market is currently expecting.

This would be considered a supportive outcome for the Pound.

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Mark Haefele, Chief Investment Officer Global Wealth Management, UBS AG, says the Bank of England stands out as one of the "hawkish" central banks while the more "dovish" central banks include the ECB, the Swiss National Bank, and the Bank of Japan.

"Assuming the recent uncertainty sparked by the delta variant is transitory, policy divergences between doves and hawks should lead to a widening in yields in favour of the British pound and the Norwegian krone," says Haefele.

He adds that "going long GBP and NOK and short EUR and CHF should provide a mid- to high-single-digit percentage upside on a total return basis over the next six to 12 months."

The spark to the recent rebound in the Pound appears to be the appearance of a number of Bank of England Monetary Policy Committee members before a Parliamentary sub-committee last week.

Governor Andrew Bailey revealed that half of the MPC already believes the minimum conditions for an interest rate rise have already been met.

This suggests the MPC might be more open to a rate hike than had previously been assumed.

"With Committee members including Governor Bailey and external member Saunders sounding cautiously hawkish and the prospect of a new more hawkish Chief Economist in Huw Pill, the arguments for a first Bank Rate adjustment from the BoE in H2 2022 are growing," says David Page, Head of Macro Research at AXA Investment Managers.

The Pound might have recovered but it still ultimately within the confines of a multi-month range and it remains too soon to assess whether the impetus exists to break new 2021 highs against the Euro.

"GBP regained its shine, for some. But we are still cautious in the short term," says Jordan Rochester, a foreign exchange strategist with Nomura.

Nomura are awaiting any Euro strength in September to play out before considering entering a trade for Pound-Euro upside.

"COVID-19 is the reason I urged caution on GBP, next week we are likely to start to see big rises in cases with the England school effect," says Rochester.

The UK enters the Autumn period with a stubbornly high Covid-19 case load which leaves scientists concerned a sizeable wave lies ahead in the colder months.

While the UK has a relatively high vaccination coverage consumers have shown a willingness to withdraw when concerns surrounding the virus spike.

Therefore, while the government might not revert to restrictions, activity could yet suffer under such circumstances.