Sterling falls off monthly highs as optimism proves premature

The pound fell back on Wednesday from one-month highs against the dollar and euro as investors realised it was too early to be optimistic about a recovery from the coronavirus crisis. Sterling's 1.3% fall against the dollar was driven by a dire global economic forecast from the International Monetary Fund, which diminished risk appetite broadly, boosting the dollar.

The global economy is expected to shrink by 3.0% during 2020 in a coronavirus-driven collapse of activity that will mark the steepest downturn since the Great Depression of the 1930s, the IMF said. "The dollar is stronger on a very broad basis and that indicates that markets remain quite nervous," said Thu Lan Nguyen, senior FX strategist at Commerzbank.

"The IMF served as a reminder that it could be a lot worse than what we've seen in recent decades and I think the market is still grappling with the extent of this crisis economically," she said. "It wasn't sustainable, this moderate cautious optimism that we've seen recently... I think the market's coming to the realisation that it's just too early for a sustainable rally."

A weakening global economy enhances the safe-haven appeal of the U.S. dollar as it is the major currency in global trade and the predominant medium of exchange in world markets. Versus a broadly firmer dollar, the pound was down as much as 1.3%, at $1.2465, erasing Tuesday's gains. Against the euro, it fell to around 87.38 pence per euro.

The pound has benefited from improved risk sentiment this month as some countries consider reopening their economies, even as experts warn Britain may be on course to become the European country hardest hit by the coronavirus. Sterling reached $1.26 in afternoon trading on Tuesday, its highest since March 13. But this optimism faded on Wednesday, overtaken by fears about the toll on the global economy.

On Tuesday, Britain's budget forecasters said the country's economy could shrink as much as 13% this year due to the government's coronavirus shutdown - its deepest recession in three centuries - with public borrowing set to surge to a post-World War Two high. While the pound was driven by global risk appetite affecting the dollar on Wednesday, domestic factors still weigh in.

Francesco Pesole, FX strategist at ING, said that most of sterling's net long positions were reduced when the pandemic started to hit Britain and Prime Minister Boris Johnson was hospitalised with the virus. "The PM's improving health condition surely provided some short-term steam to GBP in the spot market but a rebuild of those GBP longs will likely be challenged by fears of a longer-than-expected health crisis in the UK and the worsening economic impact," Pesole said.