No further curbs says JohnsonGBP jumps against most major currenciesHSBC upgrades Bank of England rate hike expectations

Picture by Andrew Parsons / No 10 Downing Street

Pound Sterling approached a key milestone in its rally against the Euro at the start of the year amidst a backdrop of cheery investor sentiment and expectations no further Covid-19 restrictions will be put in place, offering the potential for further gains by the UK currency.

The Pound to Euro exchange rate rose to the cusp of 1.20 on the day traders in London returned to the market and Prime Minister Boris Johnson said he was minded to keep existing restrictions unchanged, despite rising Covid-19 cases.

Johnson told a press conference held at 10 Downing Street, "we have a chance to ride out this wave without shutting down our country once again... but weeks ahead are going to be challenging".

The Pound to Dollar exchange rate rose half a percent to 1.3550 as Sterling advanced against the majority of its major peers.

"Some relief that the government appears unlikely to increase restrictions due to Omicron may be helping to support GBP, while relatively heavy short GBP market positioning (according to leveraged funds CFTC data) could also limit further GBP selling," says Clyde Wardle, Senior EM FX Strategist at HSBC.

Reference rates at publication:

GBP to EUR: 1.1988 \ GBP to USD: 1.3536High street bank rates (indicative): 1.1752 \ 1.3257Payment specialist rates (indicative: 1.1930 \ 1.3468Find out more about specialist rates, hereSet up an exchange rate alert, here"The ability of GBP-USD to hold the line above 1.35 probably reflects the lack of further restrictions in the UK by the British government, but also reminds investors that, given prospects of more rate hikes at home, sterling has still room to fight the firmer USD and may show more room for appreciation against the EUR, given the ECB’s reluctance to consider the start of a rate-hike cycle this year," says Roberto Mialich, FX Strategist at UniCredit Bank.

The UK reported a further 218K new Covid cases on January 04, although the reporting of figures has been distorted by the New Year holiday period. Regardless, the country is experiencing an unprecedented wave of infections, even if hospitalisation and death rates are significantly lower than in previous waves.

But for the Pound what matters is the severity of measures imposed by the government to control the spread of the virus, combined with the degree to which consumers hunker down to avoid catching it.

That Johnson is not yet willing to impose fresh measures will limit further damage to the economy from a policy perspective and should the Omicron wave peak and recede during January then expectations for a rebound in economic growth in February look well placed.

"Omicron appears to be dealing a substantial blow to economic activity at the turn of the year, but the good news is that GDP should be rising again in February," says Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics.

Should consumer and business confidence recover accordingly the Bank of England could feel emboldened to raise interest rates again in February.

The prospect of higher interest rates in the UK relative to elsewhere would in turn prove supportive of the Pound as foreign capital flows into the UK to take advantage of the superior yields on offer.

"Should the BoE stick to its script and continue raising rates to control inflation, which is expected to remain high this year, then GBP/EUR could be on for a move above €1.20 soon," says George Vessey, a foreign exchange analyst at Western Union Business Solutions.

Above: GBP/EUR at daily intervals.

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However, Vessey cautions the market might witness a corrective pullback in the short-term given the GBP/EUR's sustained advance over the past couple of weeks.

"Over the last 5 years, the average rate in January for GBP/EUR has been €1.13. With the current spot rate over six cents higher, British importers have an opportunity to capitalise, despite UK-EU trade uncertainty posed by the new post-Brexit customs checks," he says.

How the Pound performs during 2022 will depend to a significant degree on whether any further Covid scares related to new variants emerge and the effect they have on the market.

Large market pullbacks will inevitably suck the Pound lower against the Euro, Dollar, Yen and Franc and therefore poses a setback to those looking for greater purchasing power.

But an end to the pandemic and a steady tick higher in equity markets could offer Sterling support.

Above: GBP/USD at daily intervals.

The UK economy must also put in the strong growth required to convince the Bank of England to raise interest rates further, as any retracement in expectations here could also stymie the currency's advance.

Economists at HSBC say they now see the Bank Rate at 1.0% by year-end.

"It seems that the furlough scheme has ended smoothly, with workers either returning to their old jobs or finding new ones," says HSBC in a note issued at the start of the year.

HSBC reduces its forecasts for the UK unemployment rate from 5.3% at end-2021 to 4.1%, they see this rate stabilising at just under 4% for 2022-23.

They have also raised their inflation forecasts and now see CPI inflation peaking at 6% in April and staying above 3% throughout 2022.

"Given these new labour market and inflation forecasts, and following the BoE’s rate

rise in December, we now expect three more hikes of 25bps each: in February, May and August 2022, taking Bank Rate to 1.00%," says HSBC.

"We expect the BoE now to move faster than in our previous forecasts – and go further," they add.