Sterling Suffering From Overoptimism. By Nicholas Hastings

Sterling has had a cold shower and there is likely to be more to come.

The currency is suffering from a classic case of overoptimism. Investors ran ahead with hopes of an early economic recovery in the U.K. that are now proving to be unfounded.

Nothing drove this home quite as much as Thursday's retail sale data - that keen barometer of consumer health.

Instead of rising 0.6% as the consensus was forecasting and reinforcing expectations of an upturn, sales plummeted by 0.6%.

"These numbers certainly pour cold water on some of the more excitable commentary about an imminent, vibrant recovery in the U.K.," said Ross Walker, a U.K. economist with The Royal Bank Of Scotland in London.

That excitable commentary has been around for some time, driving the pound up from this year's low of about $1.3850 in early March to nearly $1.66 a week ago.

Technical forecasters say that if the pound breaks below key support at $1.6088, it will head down to $1.53-$1.54 territory.

Even before the sharp downturn that took place after the release of the retail sales data, the pound was starting to look exhausted - battered by investor doubts that with unemployment still rising and wage growth declining consumers could hardly still be spending.

Bank of England Governor Mervyn King had only added undermined confidence further by warning in his speech to the Mansion House this week that the path to a full economic recovery could prove "protracted" as banks have insufficient capital to finance a sustained recovery.

News that the government's public-sector borrowing had reached a new record high of nearly GBP20 billion in May alone only added to woes.

As James Knightley, a senior economist with ING Financial Markets in London, pointed out, this size deficit will "only increase pressure on the government to cut spending growth further and raise taxes, which will limit the potential strength of the economic recovery over the next couple of years."

Meanwhile, the pound isn't being helped by growing calls from King as well as Chancellor Alistair Darling for greater regulation in the City of London that could drive some financial institutions away.

The fact that King and Darling can't agree on the direction of this regulation only makes matters worse.

With all these pressures on the pound coinciding with a fresh rise in global risk aversion and a move out of risky assets, it isn't surprising that sterling will find more cold showers are on their way.

Early Friday in Europe, the pound did get some help from a rise in risk appetite, rising to $1.6342 by 0645 GMT from $1.6303 late Thursday in New York, according to EBS.

Improved market sentiment, helped by Thursday's better-than-expected U.S. economic data and a rebound in global equities, also boosted the euro. The single currency rose to $1.3916 from $1.3889 and to Y134.87 from Y134.14. The dollar was also up at Y96.89 from Y96.60.