GBP/USD recovers back to 1.3250, though UK Omicron/lockdown risk remains a key focus

• GBP has recovered on Tuesday amid a broader pick-up in risk appetite, lifting GBP/USD to near 1.3250.
• Omicron risk continues to weigh on the pair, though holiday conditions may well prevail until the year’s end.

GBP has strengthened in tandem with other more risk-sensitive currencies on Tuesday, a function of a broader recovery in risk appetite across markets. GBP/USD has thus rallied from earlier session lows close to 1.3200 to current levels just under 1.3250, where the pair trades higher by about 0.3% on the day. The main support to the downside is the recent lows in the 1.3150-70 area, while to the upside, there is the 21-day moving average at 1.3280.

The latest reports from UK press suggest there will be no new lockdown announcement on Tuesday, though traders will remain on notice for an announcement that could come later in the week. It seems very unlikely that restrictions would be imposed this side of Christmas given the opposition UK PM Boris Johnson faces from within his Cabinet, with UK press speculating this week that a short “circuit-breaker” lockdown could be imposed as soon as the 27^th to prevent the NHS from being overwhelmed.

The risk that Omicron presents to the UK economy was laid bare in a survey released earlier in the session on Tuesday. The CBI Distributive Trades Survey, out at 1100GMT, saw its headline index drop to 8 from 39 last month, much larger than the expected drop to 24. That marks the lowest reading since March, when the UK was still in a strict lockdown. If the UK is headed into lockdown at the end of the month, survey data in January looks set to reflect a further deterioration in sentiment.

All of this near-term risk for the UK economy has clearly weighed on GBP in recent sessions and is likely one reason why the currency was unable to hold onto its post-surprise BoE rate hike gains last week. Markets are clearly not particularly confident the bank will be able to follow up that first rate hike with another on in February. But there is some good news from South Africa; Omicron infections have now fallen for a third straight day and hospital admissions are also slowing, having never challenged peaks in last waves anyway. The hope is that Omicron will follow a similar path in the UK and, in the end, the outbreak will only cause temporary economic disruption rather than inflicting lasting damage.

But if this optimistic scenario is the case, that means the Omicron outbreak is also likely to be less severe in the US. Regardless, amid a strong US labour market recovery and with inflation sticky at elevated levels, the Fed seems eager to press ahead with monetary tightening. USD strength may have to wait until early next year, with FX markets likely to remain in holiday mode into the year-end, but things are looking bullish for the buck. GBP/USD looks vulnerable to break below recent lows in the 1.3150 area.