Waiting For The Pound To Fall. By Nicholas Hastings

Sterling's resilience will soon ebb away.

If disappointment about the U.K. recovery doesn't do the trick, then a rally in the dollar will.

Confidence in the pound's prospects is declining with some strategists now suggesting that the currency should be hedged at current levels.

Michael Klawitter, senior currency strategist with Dresdner Kleinwort in Frankfurt, sees substantial downward risks taking the U.K. currency all the way down to $1.43 by the end of the year.

Rather than forecasting sterling weakness,(the forecast)predominantly reflects our conviction that the dollar will eventually reverse its downward trend and will re-strengthen across the G10 grid," Klawitter said.

For the last two months, sterling has defied the Cassandras.

Instead of falling as expected on worries about the U.K. economy and fears about the country's growing budget deficit, the pound has continued to trade in a narrow range above $1.60.


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It has been helped by a combination of improved global risk appetite - that has brought relatively higher-yielding currencies into favor as well as an overall decline in the dollar that has driven the U.S. currency's trade weighted index to its lowest level for the year so far.

Speculation that the U.K. economy is climbing out of recession has also helped. On Thursday, a Nationwide report showing 1.3% rise in house prices this month added to the optimism.

However, analysts agree that there is plenty other data suggesting such a rise isn't sustainable. Mortgages remain in tight supply, activity in the housing market remains extremely low and any rebound in consumer demand will be muted.

"In an environment of rising unemployment and muted wage growth, the lack of credit availability means that the consumer recovery is going to be mild," said James Knightley, senior U.K. economist with ING Financial Markets in London.

Add to this, the sharp deterioration to the U.K.'s fiscal position; the continued risk of a credit downgrade; the rumbling problems of the financial sector to which the U.K. economy is closely allied; and the drag that a slow euro-zone recovery will pose for the U.K. economy and there is little reason to expect investors to continue supporting the pound.

But, as Klawitter argues, it will more likely be the dollar's performance that will spell the end of the pound's ability to remain over $1.60.

Support for the dollar is expected to rise in the coming months as it become increasingly evident that the U.S. economy is coming out recession faster than the U.K. or the euro zone and that recent fears about inflation risks in the U.S. are unjustified.

Recent fears of diversification of central bank reserves are also likely to abate as it becomes evident that there remains no alternative to the dollar.

Lastly, Klawitter pointed to the shrinking current account deficit.

"This should help to put the U.S. on a more sustainable growth path which again should be medium-term dollar supportive," he said, forecasting that it is only a matter of time before the pound heads down.

Early Friday in Europe, a fresh wave of risk appetite is providing support for most higher-yielders with the pound rising to $1.6558 by 0645 GMT from $1.6493 late on Thursday in New York.

News that the 7-year U.S. Treasury auction had been well received helped to lift global sentiment with equities posting strong gains and commodity prices rising. The euro was able to push ahead to $1.4125 from $1.4071 and to Y134.60 from Y134.35.

The dollar is down at Y95.26 from Y95.50 as the market now waits to see if U.S. GDP data later today will shows the contraction in the economy slowing to -1.5% in the second quarter from -5.5% in the first.