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Adam Dale
December 13, 2021

Pound to Euro Rebound Risks Being Undermined by New Covid Restrictions

Sterling Remains Under Pressure Amidst Risk Off Tone

GBP

The Pound to Euro rebound risks being undermined by new Covid restrictions, the weight of which could potentially act to pull Sterling back yet further as Plan B is placed into action by the UK government.

As a result, the pound continues to see downward pressure against both the euro and US dollar with GBP/EUR rates remaining stagnant at around the 1.17 level as the Omicron variant weighs heavily on the outlook for the UK economy.

The most recent data suggests that Omicron has a very high growth rate and is spreading rapidly. S-gene drop out cases have grown from 0.15% of cases during the week of 21st November, to 3.3% of cases since 5 December in England. There are currently 568 confirmed cases across the UK and early analysis from the UK Health Security Agency suggesting the doubling time could be as little as 2.5 to 3 days.

These fears were further cemented by the Health Secretary, Sajid Javid, who stated anecdotally “The Omicron variant is spreading at a phenomenal rate,” and noted that early data suggests the new variant makes up around 40% of infections in London.

Expectations of a stronger fall in Sterling surrounding Omicron have been somewhat tempered for now, with the UK government gambling on an unprecedented ramping up of vaccinations, rolling out 1m booster jabs a day to stem an incoming “tidal wave of Omicron” and avoid imposing further restrictions.

As we look to this Thursday’s Bank of England meeting for the announcement of the latest monetary policy decision, expectation of a rare December rate hike has been dampened. With inflation still running high, some economists still see a market moving surprise on the cards with a rate hike to 0.25% potentially signalling a move to the upside for the Pound, releasing much of the recent downward pressure.

Should this not happen however, we may see a further reversal of strength for the Pound as was seen in early November, when expectations were running high for a rate hike. This non-movement saw Sterling drop from its 20-month highs back down to 1.16 GBP/EUR, showing potentially more trouble for the Pound ahead.

EUR

As we look across the channel, the tougher and faster actions of many European nations may have allowed for a slightly more certain outlook which has helped see the euro gain against the pound in recent weeks.

The Omicron Variant has still seen dramatic pressure placed upon the single currency and the harder restrictions have led to several events of civil unrest across European cities, potentially causing trouble for the eurozone economy.

The European central bank has been monitoring the situation closely and taking the changes seriously but, as of yet seem not to be positioning themselves for any rate hikes.

For the euro, the contrasting monetary policy path with the US, where the Fed is actively creating space to raise rates soon if needed, is stark. The diverging assessments of US and Eu inflation paths and policy rate expectations can continue to keep the USD strong in the near-term between the most popular currency pair.

Euro weakness could extend further if the wave of COVID-19 infections across the EU forces more stringent social distancing measures while an exacerbation of gas shortages could add to economic disruption.

USD

The dollar stabilised its recent gains, remaining relatively quiet as markets prepare for a busy central bank calendar week, headlined by the two-day Federal Reserve meeting on 14-15 December.

The Fed’s likely accelerated tapering of its bond buying programme creates room for its interest rate to be lifted sooner than was previously thought by the market and Wednesday’s updated economic forecasts will provide a loose guide to how much sooner the bank’s rate setters expect this will be.

No less than 10 voting members of the Federal Open Market Committee – a decisive majority – have indicated in recent weeks that they could support a decision to end the $120BN per month QE programme sooner than the June 2022 date that was envisaged and announced in November.

With annual inflation rate stood at 6.8% in November, accelerating at its highest level since 1982, the Fed does appear to be priming for a rate rise to combat this inflation. However, the US dollar remains vulnerable to Omicron-related news, as a potential hit to the global economy could cloud the outlook and delay stimulus and rate lift off.

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