Sterling's September Roll Coming To An End. By Nicholas Hastings

Sterling may have spent most of September on a roll.

However, the currency's gains aren't convincing and the pound is more likely to head down again.

The problem for sterling is this - the U.K. economic recovery is unsustainable and the chances of the Bank of England extending its program of quantitative easing once again remains high.

For the time being, the pound is benefiting from general optimism in global financial markets and a renewed rally in global equities on hopes that the worst of the recession is over.

Data such as U.K. manufacturing output figures Tuesday, which showed a surprisingly strong 0.9% improvement in July, have helped to feed the rally that has lifted the pound about 4 cents to over $1.65 since the start of the month.




Nevertheless, the data still suggest a lagging domestic economy that will ensure the country's recovery as a whole is well down at the bottom of the G10 league table.

The faltering economic upturn is much more evident in figures from the British Retail Consortium, which showed that sales fell 0.1% in the year to August, the first decline since May.

This has ensured that economists now expect the Bank of England to postpone rate hikes until as late as the third quarter of next year. And before then, there could be further easing in monetary policy to come.

Dovish comments from U.K. officials have encouraged speculation that the BOE will increase its asset purchase program as early as this Thursday, when it holds its next policy meeting.

There is also the possibility of a cut in interest rates paid on bank reserves, another option that suggests the BOE remains eager to ease policy even further - even if this runs counter to talk of tighter monetary policy elsewhere in the world.

Policy apart, the pound could also be vulnerable from a reversal of the equity inflows that are providing some support. This week, takeover talk has been dominated by a GBP10 billion bid for the country's premier chocolate maker, Cadbury, by the U.S. food giant, Kraft.

Simon Derrick, a senior currency at Bank of New York Mellon, notes however that U.K. fixed income markets are already suffering a net outflow because of concerns about the size of the government's public deficit and the difficulties it could face in financing the gap.

As the public debate over the issue heats up ahead of a general election next summer, U.K. equities could also find themselves falling out of favor.

There are already fears that proposals for increased financial regulation discussed at the meeting of G20 finance ministers last weekend will hit London's financial center and make U.K. stocks that much less attractive.

"Should the inflows into equities falter, the pressure on the pound could become rather more severe," Derrick warned.

Early Wednesday in Europe, the pound was up at $1.6530 by 0645 GMT from $1.6500 late Tuesday in New York, according to EBS. Like other high yielders it was benefiting from the continued improvement in risk appetite, although there are signs that this is being tempered.

While the Dow Jones Industrial Average gained 0.6% Tuesday, the Nikkei fell 0.8% and the Shanghai Composite lost 0.3% earlier Wednesday.

The pound also got a little lift from the news that rating agency Moody's Investors Service said the U.K.'s triple-A sovereign debt rating isn't under threat.

The dollar rose to Y92.47 from Y92.26, while the euro was up at Y134.08 from Y133.71 and at $1.4500 from $1.4489.