Pound Sterling gains but virus variants remain a concern

• British pound to US dollar (GBP/USD) exchange rate challenging peak levels
• US dollar’s (USD) taper talk-fuelled gains fade in currency markets
• Pound Sterling (GBP) upside threatened by the growing spread of the Indian variant in the UK
• Euro (EUR) more appealing as Eurozone recovery expectations improve

Pound Sterling (GBP) started the week on a strong foot, supported by UK reopening optimism as the third round of COVID lockdown easing got underway in the country on Monday 17th May.

From May 17th, Britons were able to dine indoors under the rule of six, meet outdoors in groups of up to thirty, travel abroad and hug loved ones.

With just one more round of coronavirus lockdown easing to go, confidence in the UK economy is growing, and as a result, the British pound (GBP) is benefitting.

Although inflation fears and Federal Reserve (Fed) taper talks sent the UK currency lower during mid-week trade, the British pound to US dollar (GBP/USD) exchange rate now displays bullish signals.

The US dollar (USD) found support after Fed policymakers hinted towards tapering stimulus measures at some point soon.

However, the greenback has renewed losses heading into the North American trading hours, with traders now regarding the Fed’s statement as “wishy-washy” rather than a firm call to action.

Although the US economy’s robust recovery outlook could drive the greenback higher, each time USD advances, it deflates after bond yields top out, and investors pile into European stocks and currencies, which have been top performers on Thursday.

At the time of writing, the British pound to US dollar (GBP/USD) currency pair is trading 0.3% higher at USD 1.4151 and could make another attempt to breach the USD 1.42 level ahead of the weekend.

The euro to US dollar (EUR/USD) exchange rate has also jumped 0.3% higher to USD 1.2213. Furthermore, given that confidence in the Eurozone economy is growing, the single currency could continue to advance in the medium term.

But while GBP/USD is grinding towards the USD 1.42 handle, the British pound to euro (GBP/EUR) exchange rate has slipped on Thursday.

Eurozone recovery expectations weighing on GBP/EUR

The British pound to euro (GBP/EUR) currency pair is hovering around the EUR 1.16 level heading into New York trading hours, weighed down by Europe’s improving recovery outlook and talks about COVID variants of concern in Britain.

After a rocky start to the year, news that the European Union will be reopening its borders to fully vaccinated travellers has increased the appeal of the single currency in May.

The EU’s accelerating vaccine rollout is also supporting the currency today, with all adults in the bloc expected to be offered their first COVID jabs by July-end.

MUFG Bank noted that positive COVID developments in the bloc are fuelling hopes of a solid economic rebound from mid-2021 and lifting the euro (EUR) higher in currency markets.

Although Britain is also moving closer to normality and pound Sterling’s (GBP) technical picture is supportive, GBP/EUR is being undermined by fears over the growing number of cases of the Indian variant in the UK.

Market analysts have warned that an ongoing surge in COVID cases could delay the unlocking of the UK economy, and as a result, some GBP bulls have turned less bullish on pound Sterling (GBP).

While most foreign exchange (FX) analysts are confident that the UK currency is recovering and that the trends of early-2021 are reasserting, a few are turning bearish on GBP.

Currency analysts at Deutsche Bank told their clients that they believe the British pound (GBP) has run out of steam to turn, arguing that the economic rebound forecast for 2021 could be overwhelmed by new variants and an uninspiring consumer-led bounce.

Deutsche Bank analysts also expect the Bank of England (BoE) to disappoint with their interest rate hike timing and that financial markets are overly optimistic.

However, the prime concern for Deutsche Bank is the view that the Indian variant could derail the UK’s reopening plans.

Virus talks weighing on pound Sterling exchange rates

Several foreign exchange analysts have expressed concern over the spread of the B.1.617.2 COVID variant, first detected in India.

Although UK Prime Minister Boris Johnson said his top scientific advisors expressed confidence that vaccines circulating in the UK are effective against coronavirus variants, including the Indian variant concern, investors aren’t wholly convinced.

Labour Leader Sir Keir Starmer criticised the UK government’s travel policy earlier this week, while Shadow Health Secretary Jonathan Ashworth said the traffic light system has made “Britain’s borders as secure as a sieve.”

He condemned the UK Prime Minister for failing to issue fines to travellers breaking the rules but allowing an open door policy for direct flights from India to arrive in the UK despite COVID variant fears.

Mr Johnson responded by stating that the “UK has one of the toughest border regimes in the world.”

He also said that there had been no “conclusive data” suggesting that Britain will need to deviate from reopening plans but at the possibility of future crackdowns if the Indian variant poses a threat to the nation.

On Monday, UK Health Secretary Matt Hancock said that local lockdown measures might need to be introduced to prevent an exponential surge. While the Prime Minister suggested that the final step to reopening the economy on June 21st could be delayed if the infection rate continues to surge.

FX analyst at Barclays, Marek Raczko, said: “We remain constructive on the GBP, but we see some near-term risks stemming from the expansion of the India variant of the COVID-19 virus.”

The UK is confident that vaccines are effective against the Indian variant. Still, given that scientists have warned that it could spread 50% quicker than the Kent strain, fears over reopening plans being delayed are mounting.

On Wednesday, UK Health Secretary Matt Hancock confirmed nearly 3,000 cases of the Indian variant in Britain – a 44% increase on the previous week.

With B.1.617.2 set to become the dominant strain in Britain, this could cause severe disruption to the Prime Minister’s lockdown exit strategy as the UK government will want to avoid putting pressure on the NHS.

As there has been no significant change in the infection rate, ministers have said it is too early to make a definitive decision and will continue to monitor the situation carefully.

Even if coronavirus lockdown plans are delayed, economists from ING Bank say that it is unlikely that this will substantially impact UK recovery due to the economic boost triggered by the May 17th lockdown easing.

ING also notes that as the prevalence of the virus in over-50s and priority groups has been stable -with most cases of the Indian variant appearing in younger people – they hold onto the view that the British pound (GBP) will remain well-supported in FX markets.