Sterling under pressure to regain strength

STERLING, which has lost ground to most other leading currencies, will struggle to get back to its former trading range of 67-70 pence to the euro in the coming months.

It broke out of that pattern in November when it went to 71p to the euro and has continued to surprise markets by falling further in the meantime.

Last week the euro hit a new high of over 80p raising questions about its long-term value, said Dan McLaughlin, chief economist Bank of Ireland.

Despite those negatives McLaughlin, commenting in the latest monthly bulletin of the bank, says the pound should recover some of the lost ground and get back to around 75p.

“The pace and severity of the move has been surprising (six months ago the consensus forecast for euro/sterling was 70 pence for mid-2008), and begs an explanation”, he said.

Interest rate differentials have swung against sterling.

Last autumn, the British Bank rate was 5.75% against a repo rate of 4% in the eurozone.

That gap has closed to 1% following three rate reductions by the Bank of England, he said.

Added to that the growing conviction that the European Central Bank will hold rates at 4% for the remainder of 2008 is making the euro that more attractive to investors, he said.

The dislocation still evident in the banking sector may also be seen as negative for the City of London and, therefore, for the British economy as a whole, implying that sterling is also acting as a bellwether for financial market sentiment.

“It is also the case that the UK Government’s popularity has fallen in the polls and that policies have been introduced which are seen as negative for non-domiciled residents”, he said.

Sterling’s decline has not raised alarm bells in policy circles due to the perception that the Bank of England believes the economy needs re-balancing, with resources moving away from consumption and towards exports and investment, he said.

“All told then, not a recipe for a strong rally in sterling, but it does now appear significantly oversold and undervalued.

“Consequently, we expect a partial reversal taking it back to 75 pence against the euro in the coming months, although it remains vulnerable to another lurch downward in the credit cycle,” said Mr McLaughlin.