Pound to Euro Rate Drops 0.50%

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Pound Sterling shed a further third of a percent to reach 1.1040 as the currency added to its 2021 losses, with investors turning focus away from Brexit politics to the country's significant covid-19 crisis.

The Pound fell after UK Prime Minister Boris Johnson put England into a nationwide lockdown, a development that is expected by economists to tip the country into another economic recession.

Economists have downgraded forecasts for the first quarter of 2021 with some saying the latest developments are likely to prompt the Bank of England to cut interest rates; the rule of thumb is that when a central bank cuts interest rates the currency it issues falls in value.

Therefore growing expectations for an interest rate cut at the February meeting of the Bank's Monetary Policy Committee will likely act as a headwind to the Pound over coming days.

"Sterling is side-lined by the ugliness of Covid and the drag of Brexit uncertainty – with the latest move in EURGBP back into the higher range. The structural setup for the UK is so similar to that for the U.S., but with such a different starting level. The UK race to vaccinate relative to the extra contagious Covid-19 strain on the loose there is what to watch over the next two months," says John Hardy, Head of FX Strategy at Saxo Bank.

Economists at Morgan Stanley have this week downgraded their GDP forecast for the first quarter from "a robust" 1.6% expansion to a "sharp" 3.4% contraction.

Should the fourth quarter of 2020 also result in a negative GDP print - as is widely expected by economists - a negative first quarter of 2021 would mean the UK records a second in the space of a year.

As a result, Morgan Stanley expect the Bank of England to cut interest rates at the February 04 meeting of the Monetary Policy Committee to 0%.

"The cut to ZIRP will signal openness to negative rates," says Jacob Nell, Economist at Morgan Stanley. "However, on balance, we expect the strength of the mid-year rebound will deter any move to NIRP, leaving rates at zero to year-end."

(NIRP = negative interest rate policy).

"Q1 GDP is still likely to be very negative as a result of renewed lock-down measures just announced. We are negative GBP short-term and long-term," says Adam Cole, Chief Currency Strategist at RBC Capital.

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Prime Minister Boris Johnson announced a new lockdown effective from Wednesday morning, asking people to remain at home and instructing primary and secondary schools to close.

The closure of schools knocked a significant amount of growth out of the economy in March, when the first lockdown closed educational settings.

"Some BoE MPC members were supportive of a rate cut in December and are certain to become more vocal if the economy is effectively mothballed through another hard lockdown. COVID and exit from the EU mean UK growth will disappoint so if incoming data does not trigger some profit taking in the Pound, the BoE may go down the vocal route of the ECB," says analyst Kenneth Broux at investment bank Société Générale.

The Bank of England has thus far resisted taking interest rates into negative territory, instead opting to wait for politicians to strike a post-Brexit trading deal and for the covid-19 pandemic to run its course while relying on quantitative easing to do most of the heavy lifting on the policy front.

The Bank said in 2020 that it expects to see the economy return to normal by Spring, but these assumptions could be tested by recent developments and market expectations for a cut to negative interest rates by the Bank at some point in 2021 have risen as a result.

The market is now expecting a 0.10% basis cut to have taken place by August.