Pulling The Carpet From Under The Pound. By Nicholas Hastings

Sterling supporters must be losing faith fast.

Over the last week or two, their spirits have been lifted by stronger U.K. data and hopes that the Bank of England might be turning more hawkish.

This optimism helped the pound to bounce nearly 5 cents against the dollar to about $l.6650.



But all this changed on Tuesday when, instead, the Bank of England Governor turned more dovish.

Sure, the latest RICS survey showed the house price index back up at levels last seen in July 2007 and U.K. inflation was stronger than the market had anticipated.

However, in his testimony to parliament Governor Mervyn King surprised financial markets when he indicated that he wasn't convinced with this recovery scenario.

King warned that the central bank could still cut the deposit rates on bank reserves - a move designed to encourage banks to make more commercial loans.

King's remarks were particularly notable as they came after the bank left policy unchanged at its meeting a week ago.

They were also made as the government itself finally acknowledged that it will have to pursue spending cuts at some stage to ensure that the country's debt levels don't start to exceed 100% of its GDP and put its triple-A debt rating at risk.

But even before King's remarks, some analysts were doubting the strength of the U.K. recovery.

Take house prices. Despite the recent rally, many still expect the market to fall back again next year. The ITEM Club predicts a decline in the first half of 2010 and then stagnation for the next two years.

Sticky inflation figures, which some have argued should make the Bank of England more hawkish, are also seen unlikely to last.

Although the headline rate for August fell to only 1.6% on the year from 1.8% last month, above expectations of 1.4%, the decline will continue, taking the rate to "very low levels next year and beyond - with a prolonged period of deflation still the main risk," said Vicky Redwood, U.K. economist with Capital Economics in London.

So with fading hopes that the Bank of England will be among the first of the major central banks to start tightening monetary policy again, sterling's prospects are once again looking gloomy.

Add to this background fears of a global trade war - given the latest sabre-rattling by the U.S. and China - as well as warnings from Moody's that U.K. banks still have a lot of bad debts to recover and the pound loses even more of the investor appeal that has been pushing it higher since the start of the month.

Early Wednesday in Europe, the pound was down at $1.6471 by 0645 GMT from $1.6495 late Tuesday in New York, according to EBS.

Sterling fell against the U.S. currency even though the dollar itself was lower elsewhere, suffering from the latest improvement in risk appetite after Federal Reserve Chairman Ben Bernanke suggested that the recession was over. Strong U.S. retail sales Tuesday and gains in global equities helped the euro to rise to $1.4692 from $1.4667.

The dollar was also down at Y90.59 from Y91.06 after Hirohisa Fujii repeated his opposition to market intervention. Fujii is expected to be named finance minister later in the day in the new DPJ government under Prime Minister Yukio Hatoyama.

The euro, meanwhile, fell to Y133.09 from Y133.60.