The British Pound rallied against the Euro on Wednesday. Traders focused on shifting market bets on U.K. and eurozone rate hikes along with concerns about the economic impact of the war in Ukraine. The Sterling jumped by 0.2% against the common currency to 83.40 pence. It traded near its highest level since February 3 of 83.07 pence it hit on February 24. However, the Pound lost ground versus a rising greenback as investors continued to buy safe-haven assets.
U.S. President Joe Biden warned Vladimir Putin that he has no idea what’s coming. News about the ongoing conflict dampened the risk-on sentiment on the market. Meanwhile, invading forces bombarded Ukrainian cities, appearing poised to advance on the capital Kyiv.
Forex markets are currently pricing in 108 basis points of U.K. rate hikes this year. That is lower than approximately 130 bps priced before the Russian invasion. Investors are also discounting just about 20 bps of rate hikes from the European Central bank by December 2022.
ING analysts noted that the lower repricing of the U.K. tightening cycle should leave the Pound a little vulnerable. Its status as a currency that is more sensitive to financial risks also weighs on the sterling, considering the size of the financial sector in the U.K. economy.
Analysts also added that European equities remain vulnerable as the world reprices European growth. EUR/GBP may bounce around in a 0.8300-0.8400 range in the near future. It could break even higher if equities take another large leg lower.
What do the Commerzbank analysts think?
Commerzbank analysts stated that forex traders are beginning to realize that the European economy will be much more heavily affected by the war in Ukraine than they initially thought. The inflationary effects might damage the common currency much more than other G10 currencies. That may occur simply because Europe depends more heavily on Russian energy supplies than other economic areas.
Market players are currently focused on the Bank of England (BoE) comments. Deputy Governor for Financial Stability Jon Cunliffe is due to give a speech later today. The sterling tumbled down by 0.2% against the dollar to $1.3293 on Wednesday, just off its lowest level since December 2021 at $1.3272 it reached on February 24.
On Tuesday, BoE policymaker Michael Saunders announced that Russia’s invasion of Ukraine would likely push Britain’s surging inflation rate higher. However, it is too soon to determine the impact on monetary policy. Monetary Policy Committee member Catherine Mann added that the central bank needs to ensure the current rally in energy prices does not feed into businesses’ longer-term pricing decisions.
On Saturday, G7 and European Union governments moved to block certain Russian banks’ access to the SWIFT international payment system. They even went one step further than many expected by paralyzing about half the Russian central bank’s $630 billion worth of gold and foreign currency reserves.
One Washington lawyer described this move as the biggest hammer in the toolshed. Authorities hope that this action will undermine Moscow’s ability to defend the rouble. Since Friday alone, the latter has lost up to a quarter of its value.
Will the sanctions work?
The United States also sanctioned the Russian Development Investment Fund. That is a huge blow for Russia’s economy. However, the move quickly prompted questions about whether targeting reserve holdings as an act of “economic warfare” may elicit a rethink by reserve managers worldwide, especially in countries that may be at loggerheads or face a potential conflict with E.U. or U.S. governments, over where to bank their national stash.
This is a potentially huge issue for world markets, considering that central bank foreign currency reserves totaled a record $12.83 trillion late last year. It showed a rise of $11 trillion over the past 20 years. That money is currently held mostly in the U.S. and European government bonds and bills. The greenback is still accounting for almost 60% of that and the Euro about 20%.
The Russian central bank had steadily divested its reserves of most U.S. dollar assets since the annexation of Crimea in 2014. Despite that, the dollar, Euro, and Pound still account for more than 50% of its holdings. The latter are located in Germany, France, Japan, Britain, Canada, the United States, and Australia.
With China refusing to either condemn the Ukraine invasion or join Western sanctions, the Chinese yuan may be one clear option for anxious reserve managers in Moscow.
