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British Pound Reaches Strongest Level in Nearly Three Years

02/21/2021 | 08:14am EST

By Caitlin Ostroff

The British pound got slammed in recent years by the twin storms of Brexit fears and a particularly bad Covid-19 crisis. But with a trade deal in pocket and a world-leading vaccine program, investors say the upside forces for the currency are now just as strong.

The U.K. currency rose to its highest level against the dollar in nearly three years Friday as sterling crossed $1.40, its first time hitting that mark since April 2018.

The British economy was among the hardest hit by the pandemic, but now the country is on course to be the first major economy to inoculate its entire adult population, after the government reached its goal of vaccinating 15 million people in mid-February. The U.K. has given the third-highest number of vaccination doses per 100 people, according to Oxford University-based OurWorldInData.org, behind Israel and the United Arab Emirates.

The fast pace of inoculations, combined with the passage of a Brexit deal at the end of last year, after a period when it appeared the U.K. could crash out of the European Union without one, has led some investors to reassess their expectations of U.K. assets.

Hedge funds had largely neutral net positions on sterling's prospects at the end of last year. This year, they have increased bets that the pound will rise against the dollar.

"There is a bit of a rerating by investors on the U.K. in general," said Chris Turner, head of foreign-exchange strategy at ING Bank. "If you compare the exponential pace of the vaccine rollout in the U.K. and U.S. compared with the rest of Europe, that's giving investors confidence in a second-quarter recovery."

Last year, the U.K. economy recorded its biggest contraction in more than three centuries as social distancing and the closure of restaurants, bars, hotels and theaters hurt growth. A higher share of national income is spent on recreation and similar services that require face-to-face contact than in other comparable economies.

The vaccine rollout is likely to put pressure on the government to relax restrictions and allow for the economy to begin reopening. Expectations for the easing of the U.K.'s current national lockdown led the Bank of England to strike a more optimistic tone at its February meeting.

The central bank's comments soothed investor fears that it would enact subzero interest rates to support the economy. Investors have worried that further interest-rate cuts would weigh on banks' profitability and weaken sterling.

Investors expect the dollar to also weaken further from additional U.S. fiscal stimulus, adding another catalyst for sterling strength.

Sterling has benefited from its perception as a riskier currency than havens like the U.S. dollar or the Japanese yen. This allows it to rally as investors rotate out of U.S. assets, betting that economies whose assets are cheaper could have a larger scope for a rebound after the vaccine rollout.

"As we are a very open economy, we are very affected by the global economic winds and therefore improvement tends to help sterling," said Oliver Blackbourn, a multiasset portfolio manager at Janus Henderson Investors.

But sterling's rise could also weigh on the country's economic recovery. It would make it more expensive for other countries to buy U.K. products and is likely to weigh on profitability of large companies with high overseas earnings, which comprise much of the U.K.'s FTSE 100 Index.

The pound could still be vulnerable to drops if the U.K. government doesn't ease coronavirus restrictions as quickly as some hope, and unexpected hurdles to the vaccine rollout could also hit sentiment. Prime Minister Boris Johnson said he expects to provide a road map toward ending the lockdown, after the most vulnerable are immunized, this week.

"Some of the optimism about the unrolling of restrictions may have gotten ahead of itself," said Jane Foley, head of foreign-exchange strategy at Rabobank. "We've still got hurdles ahead."

Write to Caitlin Ostroff at caitlin.ostroff@wsj.com

(END) Dow Jones Newswires

02-21-21 0814ET

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