Overall, the global risk appetite has remained stable over the past 24 hours, which has supported the UK currency.
There has also been optimism that the UK government’s stance on the coronavirus will reduce economic damage and allow the Bank of England to raise interest rates further.
The exchange rate of the British Pound against the Euro (GBP / EUR) recorded a further sharp advance to new 22-month highs just below 1.2200 before a slight correction.
The pound-to-dollar exchange rate (GBP / USD) also ensured a net gain near 1.3550.
Markets hope damage caused by Omicron in UK can be contained
Prime Minister Johnson has resisted pressure for further coronavirus restrictions in England and called on the country to overcome the Omicron wave despite short-term pressure on the NHS.
MUFG notes relative optimism on UK outlook; “Market participants have become less fearful of the potential disruptive impact of the new Omicron COVID variant on the outlook for the UK economy, encouraged by reports that symptoms are milder and by optimism than wave could also reach a peak earlier. “
HSBC added; “Some relief that the government seems unlikely to increase restrictions because Omicron may help support the GBP.”
ING has also taken a positive position; “The UK government’s decision to weather the Omicron push with relatively few restrictions appears to have paid off by investors. Here, the rationale appears to be that an open economy and still high energy prices will keep the risk of further BoE tightening in February. “
UK yields continued to rise on Tuesday with relative yield spreads supporting the UK currency.
Mizuho’s senior economist Colin Asher expected yield trends to support the pound; “The outlook for European rate hikes is very dim and the outlook for UK rate hikes is pretty good.”
The dynamics will be different, however, if the government is forced to back down.
Crédit Agricole also notes that risk appetite could be fragile with the rise in interest rates; “The normalization of central bank policy may trigger a further tightening of global financial conditions and undermine risk sentiment.”
Hedge funds exit short pound sterling positions
If the pound sterling makes further gains, the pressure to reduce short positions will intensify.
MUFG notes the potential for shorter coverage; “Short sterling positions among asset managers / institutional investors hit multi-year highs in early December. The reduction in these positions likely played a role in the pound’s outperformance during the holiday season.
Credit Suisse takes a similar point of view; “In terms of positioning, IMM data points to a persistent short GBP position in the market. The consistency of this backdrop has been a source of encouragement for our positive stance on the pound sterling throughout our bullish phase for most of the past 12 months. ”
ING added; “We have a window – probably in 1H22 – for EUR / GBP to test early 20’s 0.8275 / 85 lows and potentially trade closer to 0.8200.”