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Sterling’s early gains fizzle

The British pound’s early gains evaporated and it turned lower. This is because the investors consolidated bets ahead of a Bank of England meeting, which is to be held next month where it is widely expected to raise interest rates. Recent data has raised expectations that the British economy is rebounding strongly from the pandemic.

GDP data had showed the economy is bigger than what it was before the first lockdown in 2020. Money markets are fully pricing in one rate hike by next month. And also, one full percentage point increase in interest rates by the end of 2022. Some economists on the other hand believe that the boost to the British economy from the pandemic rebound may be over. And so, the economy is likely to face stiff headwinds in the coming months. This is because of the widening supply chain shortages following Brexit. Hence, the policymakers might raise interest rates only twice in 2022.

BofA strategists said that they think the UK rates market is aggressively priced for UK rate. Which they think will be hard to crystallise and the risks to the pound are therefore very clear. Against the U.S. dollar, the pound edged 0.2% lower at $1.3658. It hit a late-October high of $1.3749 last week. Sterling also weakened by a similar margin versus the euro at 83.55 cents. The pound has rallied nearly 4% since the December. As the broader currency markets have been lifted by a more optimistic global growth outlook, this has resulted in a swing in trading positions by hedge funds on the pound.

The Fed’s recent hawkishness has also boosted the pound’s appeal. This is as investors bet it would give the Bank of England greater confidence to raise interest rates and tighten policy. Goldman Sachs strategists said that the Fed’s shift towards more aggressive policy action will likely push the market to expect similar moves from central banks. Which is like the BoE that were already taking steps in that direction. Within this context, it is also worth noting that the Fed’s apparent preference for earlier balance sheet action makes the BoE’s own runoff plans less idiosyncratic. They thought that could have held back GBP’s response to policy action. Which is after lowering their euro/pound forecast to 83 pence over the next three months from 86 pence earlier.

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