GBP/USD and GBP/EUR soften ahead of Bank of England meeting

• UK reopening optimism has run out of steam with political risks in focus
• Pound Sterling (GBP) slips as currency traders turn cautious ahead of Bank of England (BoE) May meeting
• US dollar (USD) struggling to find momentum
• Canadian dollar (CAD) outperforming ahead of the weekend

Pound Sterling (GBP) has retreated against the US dollar (USD), euro (EUR) and other major trading rivals ahead of the weekend as excitement over recovery prospects fade and political risks return to focus.

The British pound to US dollar (GBP/USD) exchange rate has tumbled by 0.9% to USD 1.382 ahead of the weekend after rallying to a high of USD 1.3958 earlier in the London session.

Pound Sterling (GBP) has also slipped lower against the euro (EUR), albeit losses are relatively small compared to GBP/USD.

At the time of writing, the British pound to euro (GBP/EUR) currency pair is trading 0.1% lower at EUR 1.1486, with disappointing European gross domestic product (GDP) data limiting demand for the euro (EUR).

Despite Friday’s losses, GBP/USD is trading 0.5% higher on the month. However, GBP/EUR has plunged by more than 2% in April – primarily due to UK-EU political tensions.

Although renewed confidence in the UK economy could see the British pound vs euro (GBP/EUR) cross reverse its fortunes next month, it will have to navigate several obstacles – the first being the Bank of England’s (BoE) May meeting.

Traders turn cautious on GBP ahead of BoE policy meeting

As the UK economy emerges from the COVID-19 pandemic, we expect the Bank of England (BoE) to occupy a relatively hawkish tone at next month’s policy meeting.

However, most market analysts expect policymakers to leave the central bank’s main policy settings unchanged. Other foreign exchange (FX) market participants also believe that the chances of any tapering are unlikely, especially after the Federal Reserve’s (Fed) recent dovish for longer stance.

With much still uncertain, traders have turned cautious, triggering a sharp pullback in pound Sterling (GBP) exchange rates.

Although the BoE has been arguably more optimistic than most forecasters, a lack of distinct newsflow over policy in recent weeks has left GBP traders with little to go off ahead of the May meeting.

That said, better-than-expected UK GDP data for January and February, combined with ongoing vaccine success, should prompt policymakers to upgrade Q1 growth expectations.

Furthermore, signs that the pace of recovery across Britain is accelerating could also mean a sharper lift in Q2 growth projections, especially with the next round of easing set to commence from May 17th.

Britain’s economic resilience is also reflected in the labour market strength as unemployment levels have declined for two consecutive months.

Previously the BoE predicted the unemployment rate peaking at 8% in 2021 but given that UK unemployment currently sits at 5% and there has been an increase in hiring, that seems unlikely.

UK Chancellor Rishi Sunak also extended the furlough scheme until September-end, allowing firms to rebuild their finances and return most furloughed workers.

Although downside risks remain, with increased reports of more lethal COVID-19 variants posing a threat to recovery, the more upbeat outlook surrounding the British economy and expectations for a consumer spending boom has lowered the likelihood of further stimulus.

The global financial institution, ING, believes that tapering could be on the cards at the upcoming BoE meeting as it has approximately GBP 110BN in gilt purchases to make this year. At its current pace of GBP 4.4BN a week, the central bank would hit its target before year-end.

However, with much still uncertain and political risks on the radar, support for pound Sterling (GBP) is being undermined.

Berenberg Senior Economist Kallum Pickering noted that “markets are reflecting on the potential risk of the Scottish vote”, which could awaken some volatility in GBP exchange rates.

While some analysts have downplayed the potential significance of the vote, depending on the outcome, this could increase pressure on the British government to hold another independence referendum.

Political risks weighing on GBP/USD and GBP/EUR

Although the optics around the British pound (GBP) remain relatively positive, the Scottish elections present a near term risk, and this appears to be undermining any potential for GBP/USD and GBP/EUR to gain.

Despite expectations for a robust recovery, pound Sterling (GBP) has been unable to capitalise on robust UK economic data.

Last week, IHS Markit revealed that Britain’s services sector – which accounts for more than 80% of total GDP – jumped to 60.1 in April up from 56.3 in March – the highest reading in seven years and yet GBP has been unable to hold onto the positive momentum.

Lloyds Bank’s Business Barometer also posted solid gains, with overall business confidence rising from 15% in March to 29% in April to record its highest increase in nearly three years.

Similarly, Nationwide Building Society reported a 2.1% increase in UK house prices for April, significantly higher than preliminary figures estimating a 0.5% increase and the sharpest monthly gain in 17 years.

Yet, pound Sterling (GBP) continues to be undermined by political risks, and GBP/USD appears to be caught in the potential cross-winds.

Losses in GBP/EUR have been minimal courtesy of disappointing European GDP data, which confirmed that the Eurozone had fallen back into recession.

According to new figures published by Eurostat, the Eurozone shrunk by 0.5% in the first quarter of 2021, following a 0.7% contraction in Q4 2020.

Nonetheless, GBP looks to end the week lower against a host of major currencies, including riskier rivals such as the Canadian dollar (CAD), as excitement over the UK reopening fades.

GBP/CAD trading near 2021 lows

Although February data missed expectations, the Canadian dollar (CAD) continues to outperform its transatlantic counterpart, the British pound (GBP).

At the time of writing, the British pound to Canadian dollar (GBP/CAD) exchange rate has plunged by 0.5% to CAD 1.7014 – slightly higher than this year’s low of CAD 1.7003.

Statistics Canada revealed that Canadian GDP grew by 0.4% in February versus expectations for a 0.7% increase.

However, the “Loonie” continues to be supported by the oil price rally, weaker US dollar (USD) and hopes for a strong US economic rebound.

Optimistic rhetoric and policy guidance from Bank of Canada (BoC) policymakers regarding the Canadian economy and global economic prospects has also supported the currency.

The BoC not only reduced its weekly asset purchases but paved the way for the central bank’s first interest rate hike – now expected to be made in H2 2022.

However, given that the Canadian government tightened COVID lockdown restrictions in April, this could unwind some of the country’s recent progress and offer support to the GBP/CAD cross.

Pound Sterling (GBP) will take cues from the BoE meeting next week. If policymakers are relatively hawkish, GBP/CAD could head higher in currency markets.