British pound outlook: UK vaccination optimism, BoE rate cut

• Pound Sterling (GBP) forecast to rally to multi-year highs against the US dollar (USD) and the euro (EUR) in 2021
• UK covid vaccination optimism driving GBP higher in currency markets
• Investors expect the Bank of England (BoE) to leave interest rates unchanged
• US dollar (USD) outperforming amid hopes for a robust economic rebound in the US

Pound Sterling (GBP) continues its winning streak this week, fuelled by UK vaccination optimism and broader risk sentiment.

Investors hope that Britain’s rapid covid vaccine rollout will allow UK Prime Minister Boris Johnson to permanently lift lockdown restrictions, thus boosting the country’s chances of a strong economic rebound.

According to a Bloomberg survey, analysts forecast the British pound to US dollar (GBP/USD) exchange rate concluding 2021 at USD 1.40, upwardly revised from predictions of USD 1.36 made a few weeks earlier.

Meanwhile, Mark Nash, fund manager at Jupiter Asset Management forecasts GBP/USD rallying to the USD 1.45 level this year and expects pound Sterling (GBP) to gain 4% against the euro (EUR).

Foreign exchange analysts at ING Bank have also upgraded their 2021 forecasts. According to FactSet, ING analysts see the UK currency rising above USD 1.50 this year – a level not reached since 2015.

ING analysts noted that pound Sterling (GBP) is significantly undervalued and that its prospects should improve greatly now that a no-deal Brexit has been avoided.

UK vaccination optimism should also drive pound Sterling (GBP) exchange rates higher over the coming weeks, especially if the country maintains its accelerated vaccine pace. If the UK can inoculate all of its most vulnerable groups by the February target, this would boost the recovery outlook for H2 2021.

Chief EMEA FX and IR Strategist at ING, Petr Krpata, said: “Sterling is now free to reap the benefits of a rapid vaccination rollout in the UK relative to the Eurozone.”

While UK businesses may be facing some disruption due to post-Brexit trade rules, the “persistent Brexit-related undervaluation that has been seen in recent years should begin to dissipate, and GBP should approach its medium-term fair value,” says Mr Krpata.

Dutch bank strategists noted that the UK’s rapid vaccine rollout provides “scope for a more robust recovery in 2Q21.”  They added that a less dovish Bank of England (BoE) policy statement should also benefit GBP, especially versus EUR.

FX markets expect BoE to leave policy settings unchanged

Most foreign exchange (FX) markets expect the Bank of England to refrain from slashing interest rates into negative territory due to the UK’s rapid vaccine rollout relative to its peers, prompting a strong rebound in Q2.

With the UK economy’s economic prospects skewed to the upside, the BoE may decide to adopt a wait and see approach at tomorrow’s monetary policy meeting.

Even though policymakers are set to publish their responses on the value of interest rates in the UK, FX participants seem hopeful that the central bank won’t be too dovish given pound Sterling (GBP) price action.

Although the British pound (GBP) could experience some volatility ahead of the BoE policy meeting, the UK currency has continued to rise over recent days, perhaps an indication that investors remain focused on the benefits of the country’s rapid vaccination programme.

However, if the central bank cuts rates to 0%, this could trigger a sharp reversal in GBP exchange rates.

The British pound to euro (GBP/EUR) exchange rate stormed to nine-month highs on Tuesday at EUR 1.1369, supported by a combination of improved risk sentiment, UK vaccination optimism and vaccine shortages in the EU.

GBP/EUR is trading on a softener note in mid-week trade but remains near monthly highs at EUR 1.1344.

However, the British pound to US dollar (GBP/USD) exchange rate is trading 0.2% lower at USD 1.3633 due to renewed demand for the US dollar (USD).

Usually, an improvement in global risk sentiment weighs heavily on the US dollar (USD). Yet, the greenback appears to be gaining support amid speculation that the United States will turn its back on the pandemic before Europe.

US dollar outperforming due to vaccine confidence

The US dollar (USD) is trading higher against a host of major currencies on Wednesday, primarily due to improved confidence in the US vaccination programme, versus the Eurozone.

It comes after the Biden administration said it would ramp up its vaccine rollout and deliver vaccines directly to pharmacies in efforts to achieve mass immunisation more quickly.

The news sent the US dollar to euro (USD/EUR) exchange rate to a two-month high, with investors betting that the US economy will recover faster than its EU peer.

Several analysts have expressed some surprise over the euro’s (EUR) apparent resilience, stating that they had expected the single currency to slide further due to the EU economy’s weak state.

While the UK’s head start in the vaccine race should allow the economy to reopen earlier than other nations, Brexit and unemployment levels are still expected to weigh on economic performance over the long-term which could be limiting any potential upside in GBP/USD.

However, the Dutch bank, ING, suspects that post-Brexit headwinds will calm down heading into 2022, as we begin to see the impact of the UK-EU trade agreement.

UK coronavirus cases also appear to be following a downward trajectory, as the daily infection rate declined for a second successive day on Tuesday.

While the COVID-19 death toll remains painfully high, nearly 10million people in the UK have been vaccinated, and with the country on track to achieve its mid-February target, pound Sterling (GBP) could gain further support.