Pound Sterling in "pre-MPC Wobble" against Euro and Dollar says Leading Analyst

- GBP volatility increases
- Trader nerves build ahead of Thursday MPC
- But fundamental positives underpinning GBP remain intact

Pound Sterling tipped to remain supported

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  • Market rates at publication: GBP/EUR: 1.1680 | GBP/USD: 1.3900
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The British Pound suffered a sharp decline on Tuesday before recovering into the mid-week session, with analysts saying the unexpected volatility could be linked to Thursday's Bank of England policy decision.

The Pound fell by 0.65% against the Euro and 0.50% against the Dollar at one stage on Tuesday but recovered through the North American trading session to record a gain against the Euro and pare its losses against the Dollar.

"Sterling has a very good run and is now having a pre-MPC wobble," says Kit Juckes, Global Head of FX Strategy at Société Générale. "Just as the biggest factor in sterling's favour in recent months has been the fading of negatives, so the weakness is the lack of clear positive news."

Strong recovery seen in GBPEUR

Above: The bounce-back in GBP against the EUR was particularly stark.

"The lack of positive Sterling-specific information is particularly important," says Stephen Gallo, Head of European FX Strategy at BMO Capital Markets. "Put differently, with little information flow, FX investors are being forced to build other variables into their narrative, such as the reasonably supportive environment for the broad USD in March, and the absence of fundamentally bullish GBP drivers."

The Pound could well experience further volatility over the next 48 hours as investors position around the Bank of England event, due mid-day on Thursday.

However, any weakness at this point in time is unlikely to be enduring say analysts.

Juckes says a correction in the market's growing bullish sentiment on Sterling has likely had a hand in recent volatility and he expects traders have started to cut back exposure on the Pound following weeks of growing bets for further upside.

"Is there anything ore serious going on? I doubt it. Relative rates remain friendly for the pound," says Juckes.

UK interest rates will come under scrutiny on Thursday when the Bank of England delivers its latest decision on policy and offer guidance as to how that policy might change in the future.

The Bank's Monetary Policy Committee (MPC) is not expected to change interest rates and will likely signal they have grown more confident about the economy's future. This could encourage the market to bring forward its expectations for the timing of an interest rate rise at the Bank, which is in turn considered supportive of the Pound.

"We consider the March MPC to be a low-risk event for the GBP this week, considering how vital the developments in Q2 will be to the BoE's overall policy stance," says Gallo.

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Some foreign exchange commentators pointed a finger of blame at news that EU legal action against the UK over issues pertaining to the Northern Ireland border as being behind the down-move in Sterling.

However, the the majority of analysts we follow agree this is a non-story for the Pound given that only a severe escalation of tensions and a potential imposition of trade tariffs by the EU as a punishment would likely shift the fundamental balances already baked into the Brexit picture.

"The narrative of fast vaccination is unchanged, GBP largely shrugged off the news on the EU commencing legal action against the UK's recent moves to unilaterally override parts of the Northern Ireland protocol. As any imminent decision seems unlikely and the process may take time, any negative impact on GBP should be limited," says Francesco Pesole, FX Strategist at ING.

Pesole adds that the GBP/EUR exchange rate in particular is likely to remain relatively well supported given that the UK's vaccination programme contrasts favourably with that of the EU. The divergence in fortunes surrounding vaccines has only grown this week following news major EU states have suspended the distribution of the AstraZeneca vaccine.

"The narrative of GBP continuing to reap the benefits of the fast vaccination programme remains intact and should keep the EUR/GBP direction skewed to lower levels," says Pesole.

"From an economic point of view, the decision of various EU member states to suspend AstraZeneca vaccinations is another headwind to the very near-term EUR prospects as it further underscores the divide between the US and EZ near term economic recovery prospects," he adds.

Foreign exchange analysts at Barclays recently told clients they expect the Euro to remain on the "weaker side" this week due to a broad set of factors.

One factor behind this expectation is the European Central Bank's decision last week to push back against recent increases in yields by announcing a faster, though yet to be specified, pace of PEPP purchases.

They note too that the number of new COVID-19 cases is increasing in EU countries once more, triggering Italy to introduce some tougher stringency measures in the most affected regions.

Another factor that could weigh against the single-currency is the upcoming local elections in Germany and legislative elections in Netherlands, which they say poses some tail risk.

The Pound-to-Euro exchange rate is seen at 1.1681 at the time of publication, the Pound-to-Dollar exchange rate at 1.3895.

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