The British pound sterling (GBP) has been the strongest performer against the US dollar (USD) of the major currencies so far in 2021, rising by as much as 3.1 per cent in February to a near three-year high.
February marked the fifth straight month of gains for the pound vs dollar exchange rate. The GBP strengthened as the UK continued its successful Covid-19 vaccine rollout and outlined plans to return to full economic activity by the end of June as the infection rate has dropped sharply.
Is there further upside potential for the pound, or are there headwinds that could limit further gains against the dollar? Is the recent dollar weakness set to continue?
This article considers the GBP/USD outlook for 2021 and analysts’ expectations for the currency pair.
Covid-19 recovery prospects drive the GBP/USD rate higher
The GBP to USD trend has moved higher since March 2020 as the US dollar weakened on low interest rates and historic government stimulus to support the economy during the Covid-19 pandemic. At the same time, the pound sterling has been gaining value as the Brexit process has provided more certainty to businesses and the vaccine rollout has proceeded faster than in other countries.
A third of the population has received at least one dose of the two-dose vaccination, progressing at a faster pace than Europe, where less than 10 per cent of the population has received a vaccination, and the US, where the rate is around 20 per cent.
The relatively high vaccination rate is increasing expectations that businesses in the UK will be able to fully reopen in the summer. With the positive economic outlook, the prospect of the Bank of England (BoE) adopting negative interest rates in the near term is receding, supporting the value of the pound. Increased optimism is also encouraging investors to rotate into equities that were most affected by the impact of the pandemic.
That has lifted the pound from 1.36 against the dollar at the start of the year to a peak of 1.41 on February 22. It has since slipped back to trade at 1.39 in mid-March.
However, Brexit could limit further gains in the currency, as it is affecting the flow of trade between the UK and the European Union (EU). Trade costs are rising because of delayed deliveries and increased bureaucracy, which could weaken trade with one of the world’s largest economies and affect economic growth. And there is continued uncertainty surrounding the relationship between the UK and the EU when it comes to services, as the trade agreement reached at the end of 2020 only covers goods. It is the financial services sector that drives the growth of the UK economy.
The relationship between the UK and EU is also deteriorating. On March 15, the EU said it is initiating legal action arguing that the UK is breaching international law in unilaterally extending a grace period on customs checks at the border between Northern Ireland and the Republic of Ireland until October. A lack of agreement could pull back the value of sterling.
In the US, the government has passed a $1.9trn economic stimulus package, which weighed on the dollar. However, the dollar found some support in March on rising US Treasury yields and increasing expectations that the US Federal Reserve could start lifting interest rates before 2023.
What do these dynamics mean for the GBP/USD forecast? Where do analysts see the exchange rate moving in the rest of 2021 and beyond?
Pound to dollar forecast 2021: do analysts see the pound holding recent gains?
Currency analysts see support for the pound this year, although they are cautious on the potential for further upside.
On March 16, analysts at Dutch bank ING said in their latest GBP/USD analysis: “Sterling 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.
“Equally, with many EU countries suspending AstraZeneca vaccinations, yet no such signals coming from the UK (with the UK already doing more than double the EU’s AstraZeneca volumes yet not detecting material problems) the narrative of GBP continuing to reap the benefits of the fast vaccination programme remains intact.”
Analysts at Germany’s Commerzbank offered a mixed outlook in their pound to dollar prediction for 2021, saying: “Expectations that the pandemic will end soon and hopes of normalisation should support the pound in the short term. However, we maintain our view that the consequences of Brexit should favour a weaker pound in the medium to long term.
“The BoE, for example, is likely to maintain an expansionary monetary policy for a long time to come. Even though it may start to roll-back its QE programme already this year, it is likely to clearly signal that it will not hike rates anytime soon.”
The Commerzbank analysts have issued a GBP vs USD forecast of 1.36 by the end of June 2021, rising to 1.38 at the end of September and slipping to 1.37 by December and holding at that level for most of 2022.
US-based Citibank has a one-to-three month GBP/USD forecast of 1.40, a six-to-12 month forecast of 1.39 and a long-term outlook of 1.40.
French bank BNP Paribas is more bullish on the pound, with a three-month GBP/USD prediction of 1.36 and a 12-month target of 1.45, which would bring the pound to its highest level since the Brexit vote in 2016.
According to Citibank analysts, “in a historical context GBP FX remains around 10-15 per cent cheap. If the base-case for Q2-Q3 widespread Covid inoculation and an ease in lockdown restrictions holds, flows into the UK’s value assets can keep GBP supported”.
Technical analysis by Citibank issued on March 15 shows that “GBP/USD quickly regained the February 2016 low and a rising channel base at 1.3834-36. Back in 2018, there was a sharp rebound that pushed GBP/USD above the previous trend high following a short-lived correction. Similar price action now may push GBP/USD above the previous trend high at 1.4237 to test a crucial resistance range at 1.4281-1.4377. Meanwhile, support lies around the pivotal 1.3657-1.3759 area.”
Citibank analysts added that “political risks for the cable may start to become more visible in the next two months as the UK goes to local elections and Scotland elects its parliament, which may limit GBP’s performance. Citi’s base case is for the Fed to taper in Q4 2021. This could cause higher US real yields and a stronger DXY. This may also weigh on GBP”.
There is potential for the pound to rise further against the US dollar and test technical resistance levels. However, uncertainty surrounding the economic recovery from the Covid-19 pandemic and trade relations with the EU could limit upside for the pound as growth in the US economy supports the dollar.
The best time of day to trade the GBP/USD currency pair is between 8am and 10am GMT when the UK financial markets open, and from 12pm to 3pm GMT when the US markets are open. Trading volumes are higher during these times, tightening spreads and typically seeing prices make the biggest moves.
As in most currency markets, the value of the pound sterling and US dollar are driven by macroeconomic factors such as gross domestic product (GDP) growth rates, interest rates, inflation and external trade. Macroeconomic data provides indications as to the overall health of the countries’ economies and whether they are attractive destinations for investors to exchange currency to make investments.
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