DJ Forex Focus
Sterling Will Crawl Sideways Now. By Nicholas Hastings
Sterling's recent rally may be over but it could take until Nov. 5 for the pound to fall back again.
The reason? Continued confusion over what the Bank of England intends to do with quantitative easing.
The whole of the pound's 5% rise in the last 10 days was driven by hopes that economic data had improved enough for the central bank to leave its policy unchanged at the next meeting early next month.
Investors, who had previously pushed sterling's net short positions to extreme levels in speculative markets, moved to cover themselves and the pound was powered steadily higher against the dollar.
The fact that this coincided with a period of improved risk appetite in global financial markets only made the pound that much more attractive.
On Wednesday, the Bank of England gave the already-happy sterling bulls additional ammo: minutes of its last meeting showed there was no discussion of raising the amount of quantitative easing from the current GBP175 billion level.
However, what the market thought was clarity about policy with these minutes on Wednesday turned swiftly into confusion on Thursday after the bank's director of markets Paul Tucker told a Scottish newspaper that an increase in QE is still possible.
As a result, market speculation of a boost to QE in November or subsequent months opened up, raising the specter once again of U.K. monetary policy being made even easier at a time when most other major central banks are starting to exit the measures they adopted to battle the credit crunch.
Disappointing economic news from the U.K. only encouraged such speculation with retail sales coming in flat for September rather than rising by 0.5% as the market expected.
This will contribute to the bearish view that the upcoming fiscal squeeze and the likely continued weakness in bank lending will ensure there is little increase in retail sales in the months to come.
As a result, any buoyancy that has been seen in the housing market, which has lifted consumer confidence in recent months, is likely to get knocked back fast and put more pressure on the BOE to increase QE by another GBP25 billion to GBP200 billion.
All eyes will now be on the latest U.K. gross domestic product data later Friday to see if the U.K. economy grew by 0.1% in the third quarter as expected, after shrinking by 0.6% in the second quarter.
After that, sterling sentiment is likely to be buffeted as the market waits to see what the central bank will actually do with policy in November. Investors will probably be reluctant to go either long or short on the pound again until they have a better idea of what the BOE's thinking is.
As the market strategy team at Citigroup said: "The sterling rally of the past several sessions is more a reflection of positioning than fundamentals. As such, we see little reason to change our negative view of the pound."
In other words, the market's view over the Bank of England's policy is as confused as it was before the rally and there is little reason for investors to expect further gains at this stage.
A return of risk appetite, encouraged by higher equity prices, helped to lift the pound a little in early European trade Friday, rising to $1.6647 from $1.6620 late on Thursday in New York, according to EBS.
The dollar rose to Y91.87 from Y91.28. The euro slipped to $1.5001 from $1.5031 but pushed ahead to Y137.82 from Y137.20.
In equities, the 1.3% rise in the Dow Jones Industrial Average was followed by a 0.2% increase in the Nikkei and a sharp 2.1% gain in the Shanghai Composite Index.
Improved sentiment about the global recovery also lifted the price of crude oil, with the price of contracts on the New York Mercantile Exchange rising another 14 cents from New York's close to trade at $81.33 a barrel.
The reason? Continued confusion over what the Bank of England intends to do with quantitative easing.
The whole of the pound's 5% rise in the last 10 days was driven by hopes that economic data had improved enough for the central bank to leave its policy unchanged at the next meeting early next month.
Investors, who had previously pushed sterling's net short positions to extreme levels in speculative markets, moved to cover themselves and the pound was powered steadily higher against the dollar.
The fact that this coincided with a period of improved risk appetite in global financial markets only made the pound that much more attractive.
On Wednesday, the Bank of England gave the already-happy sterling bulls additional ammo: minutes of its last meeting showed there was no discussion of raising the amount of quantitative easing from the current GBP175 billion level.
However, what the market thought was clarity about policy with these minutes on Wednesday turned swiftly into confusion on Thursday after the bank's director of markets Paul Tucker told a Scottish newspaper that an increase in QE is still possible.
As a result, market speculation of a boost to QE in November or subsequent months opened up, raising the specter once again of U.K. monetary policy being made even easier at a time when most other major central banks are starting to exit the measures they adopted to battle the credit crunch.
Disappointing economic news from the U.K. only encouraged such speculation with retail sales coming in flat for September rather than rising by 0.5% as the market expected.
This will contribute to the bearish view that the upcoming fiscal squeeze and the likely continued weakness in bank lending will ensure there is little increase in retail sales in the months to come.
As a result, any buoyancy that has been seen in the housing market, which has lifted consumer confidence in recent months, is likely to get knocked back fast and put more pressure on the BOE to increase QE by another GBP25 billion to GBP200 billion.
All eyes will now be on the latest U.K. gross domestic product data later Friday to see if the U.K. economy grew by 0.1% in the third quarter as expected, after shrinking by 0.6% in the second quarter.
After that, sterling sentiment is likely to be buffeted as the market waits to see what the central bank will actually do with policy in November. Investors will probably be reluctant to go either long or short on the pound again until they have a better idea of what the BOE's thinking is.
As the market strategy team at Citigroup said: "The sterling rally of the past several sessions is more a reflection of positioning than fundamentals. As such, we see little reason to change our negative view of the pound."
In other words, the market's view over the Bank of England's policy is as confused as it was before the rally and there is little reason for investors to expect further gains at this stage.
A return of risk appetite, encouraged by higher equity prices, helped to lift the pound a little in early European trade Friday, rising to $1.6647 from $1.6620 late on Thursday in New York, according to EBS.
The dollar rose to Y91.87 from Y91.28. The euro slipped to $1.5001 from $1.5031 but pushed ahead to Y137.82 from Y137.20.
In equities, the 1.3% rise in the Dow Jones Industrial Average was followed by a 0.2% increase in the Nikkei and a sharp 2.1% gain in the Shanghai Composite Index.
Improved sentiment about the global recovery also lifted the price of crude oil, with the price of contracts on the New York Mercantile Exchange rising another 14 cents from New York's close to trade at $81.33 a barrel.
23 October | 
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