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Pound Rises as COVID-19 Lockdown Measures Loom in Europe

The pound to euro exchange rate reached a fresh 21-month high yesterday as rising cases of Covid-19 across Europe increased market concern that European states could soon follow Austria’s lead and impose new restrictions and lockdowns. The pound’s rise to 1.1932 can largely be attributed to a decline in the euro rather than anything domestically based.

Eurozone Consume Confidence plummeted to -6.8 against a market consensus of -5.5, which meant a decline of -4.8 month-on-month. The drop in confidence appears to be down to two main causes. Firstly, the rapid rise in Covid-19 cases, which is pushing EU states towards further lockdowns that will be economically damaging during a period when the economic recovery is fragile. And secondly, rising inflation, which is a global problem, but soaring energy prices in Europe are now squeezing consumer income during a period when real wage growth is suffering.

Austria and the Netherlands have now both reinstated lockdown measures and other members of the single currency could follow as the block battles the rise in cases. In addition, the European Central Bank has been particularly dovish when faced with the question on inflation, noting high inflation levels are transitory and not a long-term problem. However, markets are aware that inflationary pressures are global, and investors are concerned by the ECB’s stance, particularly given the ECB has given no indication that a rate rise is anywhere near.

December rate hike supporting sterling

October’s inflation numbers are continuing to support the pound as investors continue to price in a 15-basis point interest rate hike for December. Currently, there is a 60-70 percent probability of a rate hike although there is a cautious approach given the Bank of England’s shenanigans earlier this month when a 15-point hike was factored in, following comments from Bank Governor Andrew Bailey and Chief Economist Andy Haldane, but never materialised, causing the pound to fall two cents against the euro.

Despite a series of economic data that points towards a rate rise, markets are nervous, especially given the bank has rarely moved rates up/down at a December meeting. The last move was in December 2008, which was during the height of the financial crisis and we then went on to see 6 consecutive rate cuts. To recall the last time the bank raised interest rates, you’d need to go back 27 years to 1994.

Furthermore, Governor Bailey had a cautious tone when interviewed by the Sunday Times. Governor Bailey stated the bank would raise rates if the economy develops as anticipated although mixed economic data means there are risks both ways. Bailey noted 3 key points. Firstly, that economic activity is slowing. Secondly, monetary policy will struggle to control inflationary issues as much of the problem is on the supply chain side. And thirdly, a concern over the jobs market and wages.

US dollar remains firm on prospect of two rate hikes next year

The US dollar is remaining strong on speculation that the US Federal Reserve will increase interest rates at least twice next year. The first rise could come as early as July with a further rate rise expected before the year end.

At home, President Biden is adopting the “stay calm” approach but rising inflation is of increasing concern, not only to American citizens but also to the Democrat party. In July, Biden stated data showed inflationary troubles would be temporary but with inflation recording 30-year high last month, Biden has been notably quiet.

Inflation is the biggest concern to the American people right now and their concerns appear to correlate to Biden’s approval rating which has been falling sharply. As prices continue to rise, it is increasingly difficult for Democrats to downplay the issue, and with mid-term elections next year, Democrats are concerned voter’s frustrations may be voiced at the ballot box. In fact, a recent poll showed 54 percent of Americans say the cost of day-to-day living is a “major crisis”.

Republicans have been quick to point the finger at Biden’s policies as the US President looks to spend trillions on infrastructure and other projects whilst hiking taxes, at a time when ordinary families are struggling to keep the roofs over their heads.

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