The pound is on track for its best month since July, buoyed by a sharp rise in UK government bond yields prompted by the brightening economic outlook and swift vaccine rollout.
Sterling has risen more than 3 per cent against the dollar since the start of February to trade near a three-year high at $1.4237, making the pound one of the best performing developed market currencies this year. The pound has also marched about 3 per cent higher against the euro to trade at €1.1707. Since the end of last year the UK currency has strengthened more than 4 per cent against the euro.
As the currency rallied, UK government bonds have suffered the sharpest monthly sell-off since 2016 as confidence among investors increased about the economy’s future. The 10-year gilt yield, which moves in the opposite direction of prices, has risen more than 0.4 percentage points in February, reaching 0.76 per cent on Wednesday. The broader global government bond market has also been under pressure, but the UK move has been sharper than regional peers such as France and Germany.
Stronger economic growth and inflation expectations dent the allure of bonds, which typically pay fixed interest payments.
“Whilst the UK’s handling of the pandemic in 2020 was lacking, it is in stark contrast to the highly effective vaccine rollout in 2021,” said Kamal Sharma, analyst at Bank of America. “We see little reason why sterling cannot continue to extend the current rally.”
Vasileios Gkionakis, head of currency strategy at Lombard Odier, said currencies had come under “brutal pressure” against sterling as a result of the rapid vaccination programme and improving infection numbers.
Economic data from the UK has made for gloomy reading, with unemployment rising to 5.1 per cent in the three months to December. Recent retail sales figures for January also disappointed last week, but investors are choosing to look beyond the impact of the lockdown to anticipate a sharp rebound in activity.
The economy is expected to grow 4.6 per cent this year and 5.5 per cent in 2022, according to a Bloomberg poll. That would represent a stark contrast to 2020 when the UK recorded its sharpest fall in output in more than 300 years.
UK prime minister Boris Johnson has outlined the government’s plan for the gradual reopening of the economy on Monday, pencilling in June 21 as the date for ending restrictions. Chancellor Rishi Sunak is also expected to outline measures to continue supporting the economy in the government’s budget on March 3.
“Our economists believe that considering the current vaccine rollout and the decrease in infection rate and potential for an expansionary March budget, the UK is well positioned for a near-term rebound,” said analysts at Goldman Sachs.
Tentative signs that UK equities are returning to favour with asset managers have also bolstered the pound. BofA’a Sharma said the pound’s longer-term performance will depend on the UK’s ability to attract inflows from foreign investors, but for now sterling is set to benefit from its positive backdrop, especially against currencies that investors rush to buy in times of stress.
“Signals are clearly aligned for a stronger sterling over the near-term,” he said.