Pound’s Pandemic Peak Versus Euro Shows Faith in Rate Divergence

(Bloomberg) --

The pound has returned from the holiday season reinvigorated against the euro as bets on a widening monetary policy chasm lift the U.K. currency.

Sterling rallied on Tuesday to 83.62 pence per euro, the strongest since February 2020, buoyed in recent weeks by hopes that omicron won't derail the U.K. economy. Money markets are bringing forward bets on Bank of England tightening, wagering that a 25-basis-point rate increase in February is nearly a done deal. That's a sharp contrast with wagers for the European Central Bank, which isn't priced to raise borrowing costs by 10 basis points until later this year.

“The pound has been one of the main beneficiaries from the ongoing improvement in global investor risk sentiment over the holiday period,” said Lee Hardman, currency strategist at MUFG. “At the same time, the stronger pound has been encouraged by the BOE's hawkish decision to follow through and start raising rates last month despite the heightened omicron uncertainty.”

A pullback in bearish bets on sterling is giving the rally legs. Asset managers cut shorts on the pound in the second half of December, having turned the most bearish on the currency since 2019 earlier in the month, according to the latest data from the Commodity Futures Trading Commission.

The pound's advance against the euro is sharpening the focus on 82.77 pence, its peak in 2019. Expiries over the next month show few option-related bids beyond 83 pence, according to Depository Trust & Clearing Corp. data, suggesting traders may be under-positioned for further strength in sterling.