DJ Forex Focus: Underlying Support For Sterling Is Ebbing Away

LONDON (Dow Jones)--Sterling's slide may have stalled, but it isn't over yet.
Like most other major currencies, the pound ended last week in limbo as the pace of the global economic recovery continued to disappoint and the recent rally in equities ran out of steam.
However, underlying support for sterling is ebbing away and the U.K. currency's fall is likely to accelerate, especially if global investors lose their appetite for risk and the dollar comes back into favor.
Since the middle of October, the pound has managed to push ahead against its U.S. counterpart, making it all the way up to $1.6837. However, the currency fell short of its high for the year at about $1.7040 and now looks vulnerable on the downside.
Technically, a more serious decline may not be confirmed until the pound falls as far as $1.6262, but a break of previous support at $1.6469 could well signal that a correction is underway.

Fundamentally, there are good reasons to expect this.
The Bank of England's inflation report last week may have raised the bank's forecast for growth as well as inflation next year.
However, the bank's Governor Mervyn King made it clear that further quantitative easing may still be employed if bank lending doesn't improve and hinted that a weak sterling would be tolerated to help the economy recover.
Economists also dismissed the upgrade in the bank's growth and inflation forecasts as little more than wishful thinking.
"We are looking for a much weaker GDP profile," said James Knightley, senior U.K. economist with ING Financial Markets in London.
He noted that fiscal policy is set to become more restrictive with households paying down debts, saving more and paying more tax at the same time that household income is under downward pressure from rising unemployment and flat wages.
Thus, any hopes of a sustainable rise in U.K. interest rate expectations are pretty slim and there is little reason to expect the pound to get support.
Adam Cole, global head of foreign exchange strategy at RBC Capital Markets in London, summed up the negative mood towards the pound: "We are not convinced sterling's rebound is sustainable in an environment where the Bank of England still appears to be manipulating rate expectations lower."
The pound could also be more vulnerable now that short-covering associated with the recent rally has left positioning in the market more balanced. This could well mean that there are more investors ready to go short of the U.K. currency once again.
How far and how fast sterling's decline eventually goes could also depend very much on what happens to the dollar itself, given that the U.S. currency remains closely correlated to the ups and downs of global risk.
Currency strategists at UniCredit suggested that while negative sterling plays are tempting, "a more intense dollar rebound is also needed to push cable back towards 1.63."
Early Monday in Europe, the pound was rising against the dollar as global appetite for risk improved, helped by stronger-than-expected third-quarter growth figures from Japan, a rally in the price of gold to a new record high and a continued strong performance by global equity markets.
The market is also anticipating the release of U.S. retail sales figures later Monday, seen showing a rise of 0.9% in October after a 1.5% fall in September.
At 0745 GMT, the pound was up at $1.6751 from $1.6690 late Friday in New York, according to EBS. The dollar was almost flat at Y89.63, compared with Y89.65, but the euro had risen to $1.4987 from $1.4920 and to Y134.35 from Y133.79.


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(Nick Hastings has covered the foreign exchange markets and industry for over 15 years. Apart from his written commentary and analysis, he also appears on CNBC television in Europe, Asia and the U.S. He can be contacted on +44-20-7842-9493 or by email: nick.hastings@dowjones.com)