The Pound continued its upward trajectory over the course of February, gaining on its rivals and consolidating its position as it hit an almost 3-year high against the US Dollar when it reached $1.40, and an 11-month high against the Euro at €1.16. The main driver continues to be the rate of the rollout of the Covid-19 vaccine among the UK population, with the milestone of 20 million jabs boosting expectations that an economic resurgence will be sooner rather than later. This has happened against a backdrop of slowing infection rates and fewer people being admitted to hospital with the virus.
The Prime Minister, Boris Johnson, announced a roadmap out of the lockdown which has crippled UK economic activity, saying most restrictions will be lifted by 21 June. There was good news too in the form of data which revealed the UK narrowly avoided a double-dip recession, with GDP growth coming in at 1 percent for the last quarter of 2020, and a new forecast of 4 percent growth this year.
The chancellor’s long-anticipated Budget addressed the high levels of debt racked up by the extra spending during the Covid-19 pandemic, although the necessary tax rises will not take effect until two years into the future.
Wednesday was an important day in the economic calendar as investors focused on the UK chancellor Rishi Sunak as he laid out the government’s taxation and spending plans for the year ahead. Mr Sunak has already warned that the Covid-19 pandemic has taken an ‘enormous toll’ on public finances – with some £300 billion spent in the last year – and fears had taken hold that the levels of taxation needed to pull the economy out of a slump would in turn hold back the recovery.
In the event, the chancellor opted to increase taxes to fill the hole in the country’s finances but chose to defer the pain for now and continue spending on support for workers, shops and businesses. In the offing was a substantial rise in corporation tax paid by companies on profits – jumping from 19 percent to 25 percent – although this will not take place until 2023. At the same time, Mr Sunak froze personal income tax brackets, as well as VAT and National Insurance contributions. There was good news for workers, with an extension of the job retention scheme until October, as well as a rise in the minimum wage to £8.91.
Rishi Sunak told the Commons he would do “whatever it takes” to put the UK economy back on the right track, promising to fix what he called the “acute damage” that had been done. In reaction to his Budget speech, Sterling remained mostly rangebound against the US Dollar and the Euro.
The US Dollar spent much of February on a weakening trend but there was a sharp reversal towards the end of the month caused by surging yields in the US bond market. For the early part of the month the Dollar was on the backfoot, but a spike in Treasury Bill yields caused by worries over inflation saw something of a correction in value.
Markets have become more confident there will be a strong global economic recovery in 2021, and as a result there is an expectation among traders that interest rates will rise. The fear of inflation has driven inflows into USD as a safe haven, with many traders expecting a US interest rate hike as early as this year.
Meanwhile, President Joe Biden’s $1.9 trillion coronavirus stimulus plan passed through the House of Representatives at the end of the month. His first major piece of legislation, the stimulus package includes a direct payment of $1,400 to every citizen, although it still requires congressional approval. The stimulus news occurred in tandem with an improvement in global risk appetite, cancelling out any potential Dollar-negative sentiment and causing a rise in USD.
Despite the appetite for USD, against the Pound, the Greenback slid from £0.73 to £0.72 over the course of February as a whole.
The Euro continued to struggle in February, beset by mixed economic data suggesting a sluggish recovery, as well as the ongoing slow rollout of the Covid-19 vaccine to EU citizens. While cases of Covid-19 are falling across the EU as a whole, an uptick in cases in France, Hungary and the Czech Republic has worried Euro investors. Currently only around 6 percent of the EU population have received a vaccine, compared to 20 percent in the UK.
In economic news, the Eurozone remained in a state of recession as the latest GDP figures for Q4 2020 revealed a 5 percent quarterly contraction, making four subsequent quarters of negative growth. According to these latest numbers, the Eurozone economy contracted by 6.8 percent last year overall, while the German economy – the largest in the Eurozone – grew by only 0.1 percent in the fourth quarter. At the same time, France contracted by 1.3 percent, which was nevertheless not as bad as feared. Nicola Nobile, lead Eurozone economist at Oxford Economics, commented:
“The short-term prospects for the European economy remain clouded by a challenging health situation in several countries and an underwhelming start of the vaccination rollout.”
This poor level of economic performance has caused some economists to call for the European Central Bank (ECB) to ramp up its stimulus measures in imitation of the USA. However, a two-day virtual summit between EU leaders was used to discuss vaccines and a potential vaccine passport, with little focus placed on economic issues. At the same time the ECB reacted to the surge in US bond yields, with policymaker Isabel Schnabel commenting that a rise in real interest rates could jeopardise the Eurozone’s economic recovery.
For these reasons the Euro weakened still further against the Pound in February slipping from £0.89 to £0.86 by early March.
February started off well for the Australian Dollar, but it wasn’t to last, and the Aussie found itself hammered lower against the US Dollar and Sterling in the last few days of the month. This sudden rush into safe havens dealt a blow to the Aussie, which lost three cents overnight to the Greenback.
While the commodity-linked and risk-sensitive Australian Dollar had seen almost a month of straight gains as risk sentiment improved, Joe Biden’s US stimulus plan sparked fears of inflation in markets, leading to a reassessment of Fed interest rate expectations. This proved too much for the Australian Dollar, which immediately relinquished three weeks of gains.
The Pound had been on the back foot against the Aussie for most of the month of February but was able to take advantage of the Aussie’s risk-related weakness and rise from AU$1.80 to AU$1.81 by the start of March. However, it then slipped back again to AU$1.79 as the Aussie once again began to strengthen on the Forex markets.
Over the next month there are likely to be several identifiable key drivers for Sterling exchange rates. Although the UK currently enjoys a strong position relative to the Eurozone in terms of GDP growth and economic performance, the risk of too much stimulus and an economic rebound causing the economy to overheat may put pressure on the BoE to raise interest rates. This, in turn, would likely cause further strengthening for Sterling. The risk of this is that the interest on the £2.1 trillion of debt carried by the state would then become more of an burden.
At the same time, the rollout of Covid-19 vaccinations will continue to act as a proxy for economic activity as far as markets are concerned. With the UK now racing ahead there is likely to be further bright sentiment towards the Pound, especially with regard to its value against the Euro.
Globally, we may find out in March whether the recent reversal in sentiment towards safe havens has staying power. Although Forex traders are currently pricing in the possibility of a medium-term rate hike in the US, more dovish words from the Fed, combined with improving economic figures in major economies could see a resurgence in risk appetite. Should this occur we’re likely to see pressure on the US Dollar once again, while the Australian Dollar may re-strengthen relative to the Pound.
The Q1 2021 GBP/EUR bank averaged forecast is €1.13, while the forecast for GBP/USD is $1.36.
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