Interest Rates Back To Haunt Sterling

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Sterling bulls should be quaking.

If interest rate expectations are now driving currencies as much as it appears, the pound's slide will only accelerate.

The Bank of England will likely add to the U.K. currency's woes if minutes of its last meeting earlier this month, to be released at 0930 GMT, show that further monetary easing is still on the agenda.

The improved prospects for the dollar aren't helping either. As U.S. economic data improves and speculation over U.S. monetary tightening increases, support for the dollar is only likely to rise at the expense of the pound.

For several weeks now, the pound has been on the decline--being pushed steadily lower after rising over $1.68 in the middle of last month.

As it gets down closer to $1.60, the slide is showing signs of getting faster, driven by a steady flow of disappointing economic data.

The latest of this came Tuesday with the contraction of third-quarter gross domestic product revised to 0.2% from a decline of 0.3% previously.

Some optimists had been hoping that the revision might have taken GDP into positive territory. Instead, the figures merely confirmed that the country lags behind the recoveries in every other major economy.

And signs are that the U.K. economy isn't going to get much stronger. Sure, there could well be real growth showing through by the end of this year.

But, noted Jonathan Loynes, chief European economist with Capital Economics in London, "with household debt still very high, credit constrained and a fiscal squeeze looming, the economy still has a lot to contend with."

"We continue to expect GDP to expand by a modest 1% or so in 2010," Loynes said.

As Loynes remarks suggest, there is little to get excited about.

Take the U.K. housing market. The latest forecast from The Royal Institute of Chartered Surveyors suggest prices will rise between 1% and 2% next year. But, the institute warns that most of this small increase will take place at the start of the year with prices falling back again in the second half.

However, it is the looming fiscal crisis that some analysts feel will not only keep U.K. growth subdued for years to come but that will ensure that the pound remains weak.

With a national debt set to reach GBP1.5 trillion by 2013/2014, the U.K. faces servicing costs that will act as a major drag on the economy, preventing it from catching up with the growth that will be taking place in other major economies.

"In the circumstances, we struggle to come up with a convincing long-term argument to support the pound," said Simon Derrick, a senior currency strategist with Bank of New York Mellon in London.

Add to this the increased speculation of dollar strength that is likely as 2010 gets underway and there appears to be little chance that the pound will be revisiting resistance up at $1.62 again just now.

Instead, UBS's forecast for sterling down at $1.56 in three months looks that much more likely.

Overnight there was very little movement in the major currency pairs with volumes low in Asia Wednesday due to Japan markets being closed for the Emperor's birthday.

Around 0730 GMT the pound is little changed from levels seen in late U.S. trade Tuesday fetching $1.5961 from $1.5965. The euro is worth $1.4259 up marginally from $1.4255 while the greenback fetches Y91.67, down from Y91.82.