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Beware a Summer Lull in Pound Sterling against the Euro and Dollar

- GBP struggles for direction as month-end beckons
- Beware a summertime lull
- But bullish case intact says UBS
- Credit Suisse eye 1.4377 in GBP/USD

Pound sterling outlook

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The outlook for the British Pound remains constructive say a number of analysts we follow, a view that if correct suggests the uninspired performance of recent days is likely to be short-lived in nature.

"Positive vaccination news and an easing of restrictions will support sterling," says Thomas Flury, Strategist at UBS.

But the call comes just days ahead of the Northern Hemisphere's summer season which could see investors press the pause button on any buying interest.

The old investor adage 'sell in May and go away' describes a perceived tendency for stock markets to underperform in the summer months and some say it could be a useful approach to adopt with the Pound given the positive correlation between the currency and broader equity market performances.

"You can instantly spot the British summertimes on a 10-year GBP-EUR currency graph because it’s usually where the graph dips alarmingly and sterling is at its weakest. Correlation doesn’t necessarily mean causation, but it’s certainly something to be wary of, this year especially," says Charles Purdy, CEO at Smart Currency Exchange.

Summer lulls for the Pound

Above: Summertime lulls in GBP/EUR.

The Pound has found itself well supported against a number of major currencies for the duration of May, however the final full week of the month has seen the currency lose upside impetus.

Those watching the market and waiting for higher levels in the UK currency would have been disappointed by the declines witnessed at the start of the week, particularly against a rejuvenated Euro.

"The euro has gained more than 0.6% versus the pound so far this week," says Ricardo Evangelista, Senior analyst at ActivTrades.

Like Flury, Evangelista touches on vaccinations but he notes the vaccine narrative is currently more supportive of the Euro than it is the Pound and Dollar.

"The EU is starting to catch up having corrected the mis-management that characterised the early days of its own vaccination program. So, with the prospects of a fast economic rebound already baked into the value of the pound, the currency is not reacting to the publication of strong economic data, while there is ample scope for further euro gains as forecasts are upgraded in the continent," he says.

The Pound-to-Euro exchange rate went as high as 1.18 in early April before paring gains and reverting back to the levels around 1.15-1.16 that have been witnessed in May.

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The major Pound exchange rates are not showing any major directional intent at present - which is actually a theme being observed right across the market - and there is a sense at some point volatility must return and trigger more notable directional moves.

When that volatility does come back, what does it mean for the Pound: will it push higher and extend the rally of the first quarter of 2021, or will it extend the pullback that we saw in April that would ultimately prove to be a bearish development?

UBS analysts say they expect positive vaccination news and an easing of restrictions in the UK will support Sterling.

In addition, "stronger global growth in the second half of this year will also favour the pound," says Flurry. "Sterling is a beneficiary of strong global growth; investment flows more easily into the UK when global growth is strong and investors are looking for opportunities," says Flury.

A global economic rebound remains the consensus expectation amongst economists who expect declining Covid case rates, increased vaccinations and ample monetary and fiscal stimulus to propel the recovery.

But the UK economy is expected to enjoy a stronger rebound than many of its peers as it was suffered signifiant contraction during in the first half of 2020 when the pandemic ripped across the world.

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UK economic outperformance rests on a rebound in activity as restrictions are eased owing to falling Covid-19 infection rates, hospitalisations and deaths and much will depend on whether this trend can continue.

A fall in hospitalisations and deaths have been aided by the rollout of vaccines which has meant 56% of the total population has had at least one dose of the vaccine.

News reports out on Wednesday show ministers are confident the vaccination programme will ramp up over the next two weeks and reach all-time highs in a major push to beat any flare-up in infections amongst the unvaccinated and recently vaccinated.

Expectations remain that the final easing of restrictions due on June 21 will take place despite rising cases of a variant that originated in India.

The unlocking of the economy in 2021 comes with the confidence that it will be the last, thanks to the vaccines. This has in turn allowed consumers and businesses to invest with greater confidence, feeding a strong rebound in activity.

"We continue to look for consumer led growth to encourage GBP/USD to breach year-to-date highs, opening up the mid-point of the long term 2014-20 trading range at 1.4302. Dips back to 1.41 remain attractive," says Jeremy Stretch, Head of G10 FX Strategy at CIBC Capital Markets.

Expectations for higher interest rates at the Bank of England over coming months and years have inevitably followed the improved sentiment, which is seen as a supportive development for the Pound's outlook.

"The Bank of England this month pretty much endorsed an implied path for interest rates that sees two rate hikes by 2024—a sharp turnaround considering that its debate at the start of the year was around taking interest rates into negative territory. This hawkish mood is likely to be maintained for the time being, lending further support to the pound," says Flury.

Pound to Dollar rate performance since 2020

Some analysts say the Pound-to-Dollar exchange rate meanwhile appears poised for further highs, particularly given the U.S. Dollar remains one of the underperformers in global foreign exchange.

Dollar weakness can run further say foreign exchange analysts we follow, a view that could well allow the Pound-to-Dollar exchange rate to crack the 1.42 level and deliver fresh multi-month highs.

Analysts say recent weakness in the world's de facto reserve currency is linked to an ongoing expectation amongst investors that the global economy is in a growth phase that has much further to run and that the yield paid on sovereign bonds will remain close to historical lows, all conditions that are typically associated with USD weakness.

"The consolidation in long term sovereign bond yields probably signals that financial markets are increasingly convinced major central banks will not prematurely reduce policy support despite improving economic activity and rising inflation pressures. This can further fuel the rally in risk assets and undermine USD," says Elias Haddad, Senior Currency Strategist at CBA.

A good portion of the most recent losses in the Greenback come on the back of fresh commentary out of the U.S. Federal Reserve.

Lael Brainard, an U.S. Federal Reserve Governor, delivered a speech on Monday in which she maintained the official line that the Federal Reserve would not entertain reducing monetary support for the economy for a while yet.

"We maintain an upside bias for 1.4302 and then the 2018 highs at 1.4377," says David Sneddon, a technical analyst at Credit Suisse, "we maintain our core bullish outlook."

While Sneddon eyes potential gains for the Pound against the Dollar, against the Euro gains are less likely to be realised in the short-term.

Sneddon's analysis of the EUR/GBP chart suggests to him "EUR/GBP is seen at risk to a move to the top of its range at 0.8702/22".

From a GBP/EUR perspective, this is a decline to the bottom of the range at 1.1491/1.1465.