Staying Loyal To The Pound. By Nicholas Hastings

Sterling bulls still aren't getting the message. U.K. interest rates will not be rising early next year as they had hoped.

The message started to get through to them last week when the Bank of England surprised the market by extending its GBP125 billion quantitative easing program by an additional GBP50 billion.

This unexpectedly large increase certainly sent a clear signal that the central bank's confidence in the U.K. recovery is substantially weaker than that of sterling bulls.

This helped to knock the pound back down from its recent high at around $1.70.

However, another rise in unemployment numbers and new fears of deflationary pressures still haven't driven the essential point home - the U.K. recovery is proving slower and more protracted than many anticipated.

This is the line the Bank of England emphasised in its latest inflation report Wednesday as it gave a more dovish economic assessment that helped to justify the need for further monetary action.

The bank's report came shortly after new data showed that the number of U.K. jobless is still rising, with the unemployment rate up at 7.8%, its highest level since 1996, and that underlying growth in average earnings is still slowing.

In other words, not only does consumption remain at risk on the downside but wage inflation pressures are likely to fall even further, possibly leaving the U.K. economy at risk from deflation.

These developments largely erase any optimism that might have been associated with signs of a stabilization in the housing market earlier in the week as this is hardly a trend that will prove sustainable if consumer demand remains weak.

In fact, some analysts reckon the Bank of England may yet have to provide even more quantitative easing to achieve the recovery it is forecasting.

For sterling, this drag on economic activity means that instead of U.K. interest rates rising in the first quarter of next year as sterling markets had been anticipating, any hike is unlikely to emerge before the second quarter at the earliest.

The data are also a timely reminder that the U.K. authorities are unlikely to encourage a rise in the pound at this time.

As the currency strategy team at BNP Paribas put it: "We continue to favor a weaker pound as it is essentially the only way for the U.K. to see any stable economic recovery as its consumer is stretched and the national balance sheet impaired."

For sterling bulls, who may have been counting on a V-shaped economic recovery with interest rates turning up again sooner rather than later, these developments may well give them reason to look for better returns elsewhere.

So far, however, they are remaining loyal to the pound.

Early Thursday in Europe, sterling had been pushed up to $1.6545 by 0710 GMT from $1.6482 late Wednesday in New York, according to EBS.

This took place as the euro found itself on the rise too, helped by the Fed's suggestion that the worst of the economic crisis is over and a general improvement in risk appetite.

The single currency rose to $1.4243 from $1.4196 and to Y137.04 from Y136.35 while the dollar itself slipped back a little to Y96.22 from Y95.05.