Most of the recent strength in the pound was due to the signing of the Brexit deal between the UK and EU before Christmas and the weakness of the US dollar. But even as these factors start to fade, the pound may strengthen this year as riskier assets come back into fashion, the UK economy stages a rapid rebound and interest rate expectations in the UK rise, analysts at Capital Economics report.
Key quotes
“The pound has been behaving more like a risky asset than a safe haven one since the start of the pandemic. Indeed, the correlation between the FTSE 100 and the pound has risen sharply since the start of 2020. So even a small further rise in investor sentiment should benefit the pound.”
“The rapid vaccine rollout in the UK has improved the economic outlook relative to its peers, especially in the EU. As a result, investors may start to favour UK assets over those elsewhere, putting upward pressure on the pound.”
“The Bank of England has recently backed away from using negative interest rates and, based on our forecasts at least, won’t expand its QE purchases. At the same time, the Fed and the ECB are likely to continue with their QE programmes for another year at least. This may push up UK rate expectations relative to those in the US and the euro-zone, driving up the pound.”
“We now expect the GBP/USD pair to rise from 1.39 now to 1.45 by the end of 2021. That’s a little stronger than our previous forecast of 1.40 and it would be the highest level since the 2016 Brexit referendum.”
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