"We continue to expect GBP to strengthen in coming months" - Citi.
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The world's largest foreign exchange dealer says it continues to back the British Pound to advance against its key partners.
Citibank says the Bank of England appears increasingly concerned over inflationary pressures in the UK and is therefore poised to raise interest rates ahead of other major central banks, including those of the Eurozone and U.S.
"We continue to expect GBP to strengthen in coming months as upside inflation risks will prompt the Bank of England to signal policy normalisation," says Ebrahim Rahbari, Chief G10 Currency Strategist at Citibank.
Policy normalisation refers to the return of interest rates and broader monetary policy levers (such as quantitative easing) to pre-crisis levels.
The playbook says those central banks that return policy to normal settings ahead of peers will bestow an advantage on their respective currencies.
"We think these risks are currently underpriced, which should fuel GBP upside over time," says Rahbari in a regular currency briefing.
Above: GBP/EUR (top) and GBP/USD (bottom) since July.
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Pound Sterling entered the previous week (commencing Sept 05) on the back foot but appreciated sharply in the second half of the week following testimony from Bank of England Governor Andrew Bailey to Parliament's Treasury Select Committee.
Bailey revealed that half of the Bank's decision making Monetary Policy Committee (MPC) felt that current economic conditions met the minimum requirements for a rate rise.
This proved a surprise given the MPC voted 8-0 in August to maintain rates unchanged.
Bailey explained that although conditions for a rate rise had to an extent been met they had not been fully satisfied.
Certainly, the Bank has indicated they would want to see the current round of quantitative easing (asset purchases) completed prior to moving on rates.
Therefore, with the quantitative easing due to complete in December the door to a rate rise in the first half of 2022 looks possible.
"Governor Bailey also highlighted acute supply challenges that seemed to be constraining output and posing risks of more persistent inflationary pressure, particularly linked to labor shortage. Markets reacted hawkishly," says Rahbari.
Citi data shows Bank of England hike pricing on financial markets for 2022/2023/2024 rose 5/6/5bp respectively on the day.
They also note the Pound strengthened in response.
But much will depend on how economic data comes in over coming months.
A key test for the MPC will be the labour market response to the completion of the government's jobs support programme in September.
Economists have been on the view that the ending of furlough would prompt a spike in unemployment which would potentially defer any interest rate rise expectations.
But, the UK is also now facing acute shortages of staff with online job vacancies at record highs, quelling fears for a spike in unemployment.
Citi nevertheless think the number of workers supported by the furlough scheme remains much higher than BoE’s forecast (1.6mil vs 500k).
"But inflationary pressure is likely to continue building, which will push the BoE one step closer to policy normalization and therefore support GBP," says Rahbari.
Citi meanwhile don’t expect last week's UK tax hikes to weigh on Sterling going forward.
They note the proposals to raise National Insurance contributions are broadly neutral for growth, as the money will be used to fund additional public spending.
The October 27 budget is meanwhile expected to deliver a further £15-20BN increase in public spending.
Regarding the pandemic, Rahbari says while Covid cases remain high, the UK should be able to avoid strict lockdown measures with booster shots planned to be delivered and hospital capacity not in particular danger.