The pound has performed better than all other G10 currencies so far in 2021 (see Chart 1), rising from $1.36 at the start of January to almost a three-year high of $1.41 now. We expect the strength of sterling against the US dollar to continue and have revised up our end-2021 forecast of $1.40 to $1.45.
- The pound has performed better than all other G10 currencies so far in 2021 (see Chart 1), rising from $1.36 at the start of January to almost a three-year high of $1.41 now. We expect the strength of sterling against the US dollar to continue and have revised up our end-2021 forecast of $1.40 to $1.45.
- A key reason why sterling has fared so well this year appears to be a favourable shift in expectations for monetary policy. Back in January, OIS-implied expectations for Bank Rate suggested investors were fully pricing in a cut from +0.10% to -0.10% within 12 months. They now suggest that investors see a much smaller chance of a cut below +0.10%. (See Chart 2.) At the same time, real longer-term yields in the UK have continued to rise relative to those in the US. (See Chart 3.)
- Meanwhile, sterling has also benefited from the broad rally in risky assets in the second half of 2020. Movements in sterling were generally correlated with shifts in global risk appetite throughout the early stages of the pandemic, and that correlation has remained relatively strong in recent months. (See Chart 4.)
- Finally, we think the recent strength of sterling can be partly explained by the continued good news about COVID-19 vaccines. As well as influencing the outlook for monetary policy and boosting appetite for risk, the vaccine rollout may have helped sterling in two other ways. First, it could conceivably have encouraged more portfolio flows into the UK stock market given its sectoral composition – the UK has a high weighting of energy and financials, which have benefited most from the vaccine-induced rotation. And second, the UK’s vaccine rollout has been especially successful, improving the relative prospects for its economy.
- Looking ahead, we doubt that sterling will get much of a further boost, if any, from shifts in expectations for monetary policy. However, we suspect that it will continue to be pushed up by growing appetite for risk, continued sectoral rotation within the stock market, and a stronger economic rebound in the UK than the consensus appears to anticipate. (See here.)
Chart 1: Changes vs. US Dollar Since 31st Dec. 2020 (%)
Chart 2: OIS-Implied Expectations For Bank Rate (%)
Chart 3: UK Less US 10-Year Real Government Bond Yields & Dollar/Sterling Exchange Rate
Chart 4: Rolling 6-Month Correlation Between
Sources: Refinitiv, Bloomberg, Capital Economics
Adam Hoyes, Assistant Economist, firstname.lastname@example.org