Currencies

Sterling on pace for its best week against the dollar since March

Key Points
  • Sterling crossed the $1.27 mark on Friday afternoon, up almost 3% for the week.
  • One potential longer term cloud hanging over the pound is the possibility of a disorderly Brexit. Britain has until the end of June to decide whether to request an extension to the Brexit transition period beyond December 31.
  • The dollar, a traditional safe haven during times of crisis, has depreciated broadly this week as investors head back towards risk.
A £10 note is seen alongside a US dollar bill.
Matt Cardy | Getty Images

Sterling is on course for its strongest week against the dollar since late March, driven by risk-on sentiment and the Bank of England's cooling of speculation about negative interest rates.

By mid-afternoon on Friday, the pound was up a further 0.75% against the traditional safe haven greenback and was up almost 2.9% for the week, having briefly crossed the $1.27 mark.

Sterling had been as low as $1.14 at the height of the mass market sell-off in late March, as the coronavirus pandemic began to sweep through Europe.

Broad dollar depreciation

The dollar, a traditional safe haven during times of crisis, has depreciated broadly this week as investors head back towards risk, with stock markets buoyed by the reopening of economies around the world and subsequent hopes for recovery.

However, even after U.S. jobs data stunned markets by revealing that payrolls rose by a record 2.5 million in May, having been expected to fall by a further 8.33 million, the dollar continued to fall, indicating that investor aversion to the greenback extends beyond market sentiment.

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"Plagued by civil unrest, mass unemployment, the Chinese trade war and limited stimulus options moving forwards, many investors that were previously using the dollar as a safe haven are now looking to other options like the Swiss franc, Japanese yen or gold as a substitute," said Sebastian Clements, currency analyst at international payments firm OFX.

"This afternoon's U.S. unemployment rate data is testament to this, as it came in 6.1% better-than-expected and on its release, we saw further USD erosion," Clements said in a note following the report.

Negative rate talk cooled

The debate over whether the Bank of England should take borrowing costs below zero in order to combat the economic fallout from the coronavirus has been a persistent focus for markets of late.

Governor Andrew Bailey has thus far refused to rule out going below the current effective zero bound, but the Bank's Executive Director for Markets, Andrew Hauser, told a Bloomberg webinar on Thursday that negative interest rates would not be a near-term possibility.

By pushing rates into negative territory, central banks "disincentivise foreign investors from depositing funds in the local economy, putting downward pressure on the exchange rate, thus contributing to easier financial conditions," Deutsche Bank Economist Sanjay Raja and Macro Strategist Oliver Harvey highlighted in a note Friday.

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Raja and Harvey suggested that further rate cuts would be a "last resort", and expect the BOE Monetary Policy Committee (MPC) to rely on quantitative easing (QE) to maintain easy financial conditions. Deutsche's base scenario is a £125 billion ($158.45 billion) expansion to QE at the June meeting, with further QE likely over the course of the year.

"As things stand, we continue to think that the MPC holds sufficient ammunition to keep financial conditions easy without the need to take rates into negative territory," the note said. "Moreover, given that the predominant response to dealing with Covid-19 has come from the fiscal side, this should alleviate the pressure for more radical monetary policy easing in the near term."

Brexit back to the fore

One potential longer term cloud hanging over the pound is the possibility of a disorderly Brexit. The U.K. and EU returned to the virtual negotiating table this week, and Britain has until the end of June to decide whether to request an extension to the Brexit transition period beyond December 31.

U.K. Prime Minister Boris Johnson has vowed not to do so, even in light of talks over a new trading arrangement being derailed by the coronavirus pandemic.

A Reuters poll published Thursday found that analysts expect sterling to give up all of its gains against the dollar and slide further if Britain does not request an extension to the negotiation window by the end of this month

In a note published Monday, analysts at Rabobank highlighted that "net short GBP positions have now moved back to their December levels as Brexit fears resume and as criticism grows as to the U.K. government's handling of the coronavirus crisis."

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AXA Investment Management Chief Economist Gilles Moec told CNBC via video conference on Friday that the market is increasingly pricing a "no-deal" departure once again.

"The U.K and sterling-denominated assets have a big problem right now, because obviously it is not among the best performers through this pandemic, so the economic rebound may come later in the U.K. than in the rest of Europe, and on top of that you have got the Brexit uncertainty," Moec said, adding that this represents "a lot of hurdles for just one currency."

Moec suggested that the market reaction to the outcome of this month's talks would be "asymmetrical," with a sharper rebound in the event of an extension or a deal being hashed out, since the downside risks of no free trade agreement, or a poor quality one, are largely priced in.