Sterling is heading for fresh falls in coming weeks as worries about a deepening recession in the UK, highlighted by the Bank of England, keep expectations of further monetary easing intact.
In its quarterly inflation report yesterday, the Bank of England forecast that the British economy will barely grow this year and cut its projections for future years, although it appeared in no hurry to pump more cash into the economy or to cut interest rates.
Sterling jumped after BoE governor Mervyn King dampened what had been growing expectations of an interest rate cut, arguing that such a move would damage some financial institutions and be “counter-productive”.
But analysts said the currency’s rise was only a knee-jerk reaction by investors who had anticipated a clear signal of additional monetary easing in the coming months.
“You can see why sterling has appreciated, but our view is that growth is going to remain weak and monetary policy will likely be eased further,” said Paul Robinson, chief currency strategist at Barclays.
“Given the prospects for the UK relative to the rest of the world, we’d still prefer to be short sterling at the moment.”
Sterling, seen for much of this year as a safe haven from the eurozone debt crisis, has been falling against the dollar and the euro in recent weeks as the UK economic outlook has deteriorated and after BoE minutes showed policymakers debated a possible interest rate cut last month.
Many analysts said the pound would soon resume its slide, especially with investors turning more positive on the euro since European Central Bank president Mario Draghi pledged to do whatever it takes to safeguard the common currency.
A worsening eurozone debt crisis pushed the euro to a near four-year low of £0.7756 last month as investors fled the euro in favour of safer alternatives, such as the pound.
But the ECB said last Thursday that it could resume buying Spanish and Italian bonds to reduce sky-high borrowing costs, eventually pushing the euro higher across the board.
As a result, the premium charged to buy bets on the euro weakening against the pound in one month’s time is now around a quarter of what it was at the start of last week.
“We see the setback in euro/sterling as just providing us with an opportunity to buy [euros],” said Hans Redeker at Morgan Stanley.
He said the euro could rise to 82p or 83p within the next couple of months, despite it falling as far as 78.8p in response to the Bank of England’s report, well below a recent one-month high that brought the 80p level into view.