Sterling will underperform other major currencies at least until the end of the year, with British policymakers appearing content for it to weaken, and with a tepid recovery keeping interest rates pinned to the floor.
The pound was on track for a decline of around 3 per cent on a trade-weighted basis last month, its steepest monthly fall this year. Against the euro, analysts said a move towards parity was possible this quarter.
Sterling's latest descent has been given extra impetus by comments from the Bank of England's governor, Mervyn King, and, before that, the bank's report saying the pound's long-term exchange rate may have fallen due to the financial crisis.
"Near-term risks for sterling are to the downside due to comments from the Bank of England," Societe Generale currency strategist Phyllis Papadavid said.
Her colleagues at BNP Paribas see the pound falling to around US$1.53 by the year's end, near levels seen in May but higher than a low of US$1.35 hit in January. "Sterling will stay weak for the next two to three years, and is likely to be the underperformer among the majors," said Hans Redeker, head of forex strategy at BNP Paribas in London. He added that a deflationary environment would allow it to weaken without fear of igniting inflation.
King was quoted recently as saying sterling's falls against major currencies were helping a much-needed rebalancing of the economy towards exports. Finance minister Alistair Darling has since said there was no policy to deliberately weaken sterling and policymakers have expressed frustration at the way markets had interpreted King's remarks. However, many in the market subscribe to the idea that a weak pound would be a good thing. Against the euro, some say sterling may fall even more sharply, possibly towards parity.
"The pound looks set to hold broadly steady against a weak dollar, but a slide towards parity against the euro is looking more and more likely all the time," said Standard Bank strategist Steven Barrow, who sees the pound holding near US$1.61.
Underpinning sterling's weakness are rock-bottom interest rates and speculation the Bank of England will further loosen monetary policy by expanding its programme of quantitative easing (an extreme form of monetary policy used to stimulate an economy where interest rates are either at, or close to, zero).
UK interest rates, along with those in the United States, are set to remain low for longer than those of other major industrialised economies because the effects of the global financial crisis are seen taking a bigger toll on those economies, making sterling less attractive.
The British economy contracted 5.5 per cent year on year in the second quarter. Even when growth resumes as expected later this year, a recovery is seen as sluggish.
That will keep speculation intact that the Bank of England will expand its £175 billion (HK$2.17 trillion) quantitative easing programme in November, when the plan runs out of funds. That is in contrast to other central banks, which are seen drawing down some of the emergency liquidity measures taken to combat the global liquidity crisis.
But some analysts say the structural background may be favourable for the pound further into next year.
"Capital inflows are picking up, and trade-weighted sterling is one of the most undervalued among the G10," Papadavid said.
Reuters
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