GBP/USD and GBP/EUR uptrend continues amid risk-on mood

• British pound to US dollar (GBP/USD) exchange rate hit three-year best
• Euro (EUR) remains resilient against pound Sterling (GBP) and US dollar (USD)
• US inflation figures to determine the direction of US dollar (USD)
• Brexit trade headwinds could undermine pound Sterling (GBP) gains

Foreign exchange (FX) strategists at NatWest forecast further pound Sterling (GBP) upside, particularly against the euro (EUR) due to the UK’s world-leading COVID-19 vaccination programme, which they expect will drive economic recovery.

In a research briefing note to clients, NatWest said the UK’s rapid vaccine rollout would likely push GBP higher, noting Britain’s clear lead in the race to immunisation relative to its European and American peers.

Despite suffering one of the worst economic downturns of any other leading economy due to coronavirus lockdown restrictions, the UK is forecast to make a swift recovery in the second half of 2021.

Economists and other financial professionals assume that the UK’s strong vaccine start should allow an earlier easing of restrictions on a more sustainable and permanent basis.

According to official statistics, Britain has vaccinated more than 18% of its population, compared to the EU with less than 4% of people across the bloc inoculated and the United States, which has vaccinated 9.9% of residents.

Should the UK reach its target to vaccinate 15 million people by mid-February, this could give the British pound (GBP) a significant advantage over the euro (EUR) and US dollar (USD).

Paul Robson, Head of G10 FX Strategy at NatWest Markets said: “A successful rollout should also mean that the Bank of England (BoE) doesn’t take policy rates negative,” which would be supportive of GBP exchange rates.

The BoE triggered some solid buying pressure behind the British pound to US dollar (GBP/USD) exchange rate and the British pound to euro (GBP/EUR) exchange rate after policymakers unanimously voted against negative interest rates.

The central bank also said its negative rates will be unlikely in 2021 as they expect a robust economic rebound to materialise once UK Prime Minister Boris Johnson reopens the economy.

However, those with pound Sterling (GBP) currency requirements should note that any outperformance in the UK currency could be short-lived as vaccine euphoria fades and the impact of Brexit exposes itself in the second half of 2021.

In that sense, the scope for further long-term upside in GBP/EUR and GBP/USD exchange rates could be limited.

US dollar tumbles amid improved risk appetite

The British pound to US dollar (GBP/USD) exchange rate rallied to USD 1.3856 earlier in the session – its highest level in three years.

While Cable has softened slightly during midday trade, it continues to trade above the USD 1.38 level. Renewed US dollar (USD) weakness could also see the currency pair breach USD 1.40 in the medium-term.

Pound Sterling (GBP) is also being supported by the UK’s declining infection rate, which appears to be reducing at an accelerated pace alongside the massive vaccination drive.

Although GBP fundamentals remain weak, improved risk appetite has reduced the appeal of safe-haven currencies such as the US dollar (USD), which is trading lower across the board.

The greenback pared some of its 2020 losses in late January amid speculation that the US vaccination programme could allow the country to recover faster than its European neighbours.

However, weaker-than-expected US unemployment figures saw the greenback reverse its fortunes, and several analysts are now forecasting an extended period of weakness in USD exchange rates.

FX markets are also anticipating a USD 1.9TN stimulus package from the Biden administration, which could see reflation trade return in full force, and as a result, drive riskier assets such as the British pound (GBP) higher over risk-off counterparts.

On Wednesday, USD traders will be focusing on Federal Reserve (Fed) Chair Jerome Powell’s speech and US inflation data, with the Consumer Price Index (CPI) forecast to remain mostly unchanged.

Nonetheless, amidst expectations for a substantial US stimulus package and the Fed’s “lower for longer” stance, the US dollar’s (USD) downtrend will likely continue in the medium-term, which will result in an increased appetite for riskier assets.

Euro remains resilient in FX markets

Improved risk sentiment appears to be undermining concerns over the EU’s laggard vaccine rollout, as the euro (EUR) is holding steady against pound Sterling (GBP) and the US dollar (USD) in mid-week trade.

At the time of writing, the British pound to euro (GBP/EUR) exchange rate is trading 0.1% higher at EUR 1.1415, while the euro to US dollar (EUR/USD) exchange rate is flat at USD 1.2117.

The single currency appears to have found some support following the release of German inflation data, which surged by 0.8% in January, to beat forecasts for a 0.5% rise month-on-month.

On an annual basis, German inflation accelerated to 1%, a significant improvement on December’s CPI but well below the European Central Bank’s 2% target.

Although the upbeat music mood in currency markets supports the British pound (GBP), GBP/EUR upside potential is being capped by nerves ahead of Friday’s release of Q4 2020 gross domestic product (GDP) data.

Although FX markets will have likely priced-in expectations for an economic contraction in the current exchange rate, the UK will also be publishing trade balance figures which will provide significant insight into the impact of Brexit on the economy.

If these figures disappoint, this could shift sentiment towards pound Sterling (GBP) and trigger some near-term headwinds for the UK currency.

Although London and Brussels avoided a no-deal Brexit, recent reports have suggested that the UK’s departure from the EU is stifling exports to the bloc, which if true, will undermine Britain’s economic recovery outlook.

While the UK’s vaccination drive could limit GBP/EUR losses, pound Sterling’s (GBP) recovery could still fade heading into the second half of 2021 as vaccine optimism fades and it becomes more apparent that the Brexit deal is weighing on growth.