Pound cools against dollar and euro as Covid vaccines boost wears off

The pound is backing down against the euro and dollar, while the optimism-fuelled drop in UK government bonds is easing, as the effect of the country’s head start in vaccines starts to wear off.

Sterling had climbed 5 per cent against the euro in the opening quarter of 2021, the UK currency’s best three-month run in six years. On April 5, it reached a high of €1.1802.

Since then, it has dropped 2.5 per cent to €1.151. It has pulled back about 3 per cent from the high it reached against the dollar in February of $1.4235 to trade at $1.3787. Ten-year gilt yields, meanwhile, have stabilised around 0.8 per cent, ending a rapid ascent as prices for the bonds stopped falling. It had traded at about 0.2 per cent at the beginning of the year.

Sterling’s decreasing fizz suggests that some of the economic advantage over the eurozone that investors had been anticipating is narrowing, especially as European coronavirus vaccination rates pick up.

“After a blistering start, further . . . gains will be harder to come by as much of the good news on vaccine[s] is likely priced in,” said Kamal Sharma, rates and currencies strategist at Bank of America.

The UK economy steadied early this year after a grim 2020, with output ticking up 0.4 per cent in February from the previous month, according to data released this week.

While gross domestic product was still down almost 8 per cent year on year, economists have grown more optimistic thanks to rapid vaccine rollouts and the easing of social restrictions. The economy is expected to expand 5 per cent this year, according to economists polled by Bloomberg.

This brightening outlook contributed to sterling’s big gains during the first quarter, but some analysts are questioning how much further sterling can climb in the near term.

“The reopening and re-acceleration [of the economy] had all effectively been priced in” during the big sell-off in UK government bonds, which lifted yields, said John Wraith, head of UK rates strategy at UBS. Higher bond yields are typically a boost to the pound, since investors often move money to areas where they can earn higher returns.

Thu Lan Nguyen, foreign exchange analyst at Commerzbank, cautioned that while economic momentum was expected to accelerate as lockdown eased, the UK faced a significant challenge, having been more heavily affected by the Covid-19 crisis early on than other economies.

She also expressed concerns over the potential impact of Brexit on trade flows, with exports and imports with the EU having tumbled by a historic margin in January.

“What will see the pound stand out is whether the UK can continue to attract investment inflows, which have been a hallmark of the recent appreciation,” said Sharma, pointing to cross-border mergers and acquisitions as a particularly significant part of the conditions needed for continued growth.