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Pound Sterling Could Weaken against Euro on UK's "Aggressive Reopening" says Deutsche Bank

- GBP at risk of impact of 3rd wave
- Could hit consumer confidence
- But EU could be about to see 4th wave

Testing for Covid

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The British Pound could yet lose value owing to a surge in Covid-19 cases according to new analysis from foreign exchange strategists at one of the world's largest foreign exchange dealers.

An assessment made by Deutsche Bank finds that rising Covid-19 cases in the UK could have a negative impact on consumer confidence over coming weeks, which in turn will weigh on spending and ultimately economic activity.

Given that the Pound's solid run in 2021 has been built on an assumption that the UK would see one of the most impressive economic growth recoveries this year, any disappointment in upcoming economic data could push the currency lower.

"We are more concerned that any minor direct boost from the July 19th reopening will be offset by indirect ripple effects of the exit wave, with issues on both the demand and supply side," says Shreyas Gopal, Strategist at Deutsche Bank.

The Pound was supported after the UK government announced on Monday July 05 that the final phase of reopening society would proceed on July 19 as they assess that the vaccination programme has severed the link between cases, hospitalisations and deaths.

The observation is borne out clearly when comparing the UK's current wave of infections with South Africa, which is undergoing a similar spike in cases:

Infections and deaths UK vs. SA

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For a country to achieve a final herd immunity against the virus - which is ultimately the only sustainable end-point to the pandemic - it is now estimated that a degree of natural immunity must be allowed to occur.

This is because the more transmissible a variant becomes the higher the level of herd immunity is.

It is not likely that any country will be able to vaccinate its entire adult population, while vaccinating young children is unlikely given the unattractive risk-benefit skew of vaccinating this age group.

In short, the government has calculated the virus will inevitably penetrate pockets of the unvaccinated population regardless of the vaccination programme.

The resultant spike in cases will nevertheless potentially have a negative impact on the economy via other avenues.

"On the demand side, there is a link between rising case rates and consumer confidence, despite vaccinations being well understood to greatly reduce the chance of severe illness," says Gopal.

Covid cases correlation with spending

Above: "UK consumer spending steady but not 'gangbusters' as Covid cases rise" - Gopal.

The analyst notes last month saw consumer confidence actually fall for those aged 50-64, despite the vast majority of this group being double vaccinated and cases not having risen anywhere near as much as in younger age groups at the time of the survey.

"In the medium term, the strength of the UK's recovery will primarily be determined by the desire of this age group, who have high purchasing power, to continue spending. Rising cases thus pose a risk here, even if the growth rate appears to have slowed slightly in recent days," say Gopal.

Businesses have meanwhile expressed concerns over the government's decision to keep its test and trace policy going until August, which requires mandatory self-isolation for those that might have been in contact with an infected individual.

For businesses, having employees forced into self isolation is highly disruptive.

The Financial Times estimates that for every positive Covid case, on average another two people have to self-isolate.

If 700k people per week are testing positive, as Health Secretary Sajid Javid suggested on Tuesday, a further 1.4 million would have to stay at home, which is 2.1 million per week overall.

The Adam Smith Institute estimates 4.6 million people a week could be forced to self-isolate until the rules are finally dropped in the middle of August.

What does all this mean for the Pound?

Gopal said that a disappointing outturn in economic data over coming weeks could see the market start to bet the Bank of England won't need to raise interest rates anytime soon.

This matters for a foreign exchange market that is currently proving highly sensitive to interest rate expectations at the world's central banks.

Those currencies belonging to central banks that lead the pack in raising interest rates are tipped to outperform those belonging to central banks happy to adopt a slower approach.

Therefore, when the Bank of England hikes matters for the Pound.

"For now we remain neutral on the pound. But given the downside risks from aggressive reopening, we are increasing sceptical of the market pricing a sustained hiking cycle from the Bank of England," says Gopal.

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The Pound has entered something of a period of consolidation against the Euro, with the Pound-to-Euro exchange rate displaying some remarkable stability in the 1.16-1.17 range.

Meanwhile, the Pound-to-Dollar exchange rate has been left almost exclusively to the whims of the Dollar which has undergone a period of appreciation owing to growing expectations that the U.S. Federal Reserve is gravitating towards raising interest rates.

A period of idiosyncratic Pound weakness could therefore lead to more notable downward moves in these key exchange rates.

Although the Pound is at risk of declines against the Euro under the scenario outlined by by Deutsche Bank, the progress of the Covid pandemic in the Eurozone should not be ignored.

For GBP/EUR to decline on rising Covid cases in the UK Covid cases in the EU must be declining, or at least be a static.

Incoming data suggests the Eurozone could be following the UK's pandemic pattern with the Delta variant starting to push up cases once more in major EU countries.

"The delta variant is now causing the infection figures to rise again in almost all European countries. In Germany, too, more new infections have been reported for two days," says Bernd Weidensteiner, Senior Economist at Commerzbank.

Covid 19 cases EU

Above: New infections per 100,000 inhabitants on average over the last seven days.

"This increases the pressure on politicians to tighten the Corona restrictions again," says Weidensteiner.

The EU's pandemic pattern tends to follow that of the UK with a lag; the Alpha variant originated in the UK and lead to the winter lockdown.

The worst of the Alpha wave in the EU was some 4-8 weeks behind that of the UK.

If EU cases start to climb it becomes possible that any GBP/EUR downside emanating from trends in the pandemic could ultimately be neutralised and the exchange rate will be driven by other factors.

As such it could be too soon to bet against the Pound until the situation in Europe becomes clearer.