Pound reverses fall vs euro but euro zone, UK concerns weigh

Dated Posted: 2011-08-11

London, Aug 10  - Sterling pulled back from a one-month low against the euro on Wednesday as euro debt problems and contagion risks dogged the single currency, but it lost ground against the dollar after the Bank of England cut its economic growth forecast.

Speculation that France could be the next triple A-rated sovereign to suffer a downgrade and a sharp fall in European stocks hurt the euro, which last traded down 0.5 percent at 87.66 pence .

Against the dollar, sterling was down 1 percent at $1.6153 as investors already disappointed by the Bank of England's quarterly inflation report reached for the relative safety of the greenback.

Near-term support is seen at $1.6120, the low hit on July 21.

"Sterling is caught between a rock and a hard place. If the market is really concerned about negative conditions in the euro zone, sterling gets caught in the cross fire," said Paul Mackel, director of currency strategy at HSBC Markets.

"The message from the BoE is it's going to be a long fight ahead, the economy is going to be sluggish. The only thing that makes this better is that sterling is in an ugly contest with the euro and dollar. It's not as if the UK is weak and the rest of the world is strong."

The BoE lowered its expectation for annual GDP growth to around 2.0 percent in the last quarter of 2011. In May, it had forecast 2.47 percent growth by the end of the year. The bank added that inflation would fall rapidly in 2012.

The euro hit a one-month high of 88.86 pence against the pound on the release of the inflation report before paring losses as market players realised there was no indication of an imminent resumption of asset purchasing to boost the economy.

Another round of asset purchasing would be negative for the currency as it would add to sterling liquidity.

"The initial move was an overreaction. The slight downgrade in the forecast was not entirely unexpected," said Adam Myers, currency strategist at Credit Agricole CIB.

"Does this push the BoE any closer to QE than the market already thought? I don't think so," he said, adding that the price of sterling indicates some investors are already betting the BoE will add to its asset-buying scheme.

Following the release of the inflation report, BoE Governor Mervyn King suggested that monetary policy would remain ultra loose -- with rates chained at a record low of 0.5 percent -- for some time as the global economy is slowing.

He said that adding to the BoE's asset-buying programme would be a possibility if the economic outlook deteriorated, but suggested that more quantitative easing may not be imminent.

POUND IN AN UGLY RACE

The pound sold off this week after a run of dismal UK economic data including figures on Tuesday showing an unexpected fall in UK manufacturing output that stirred speculation of a downgrade to the BoE's growth forecast.

Some analysts say sterling has room to rise if a deteriorating debt picture in the euro zone increases the appeal of gilts as the UK continues drastic austerity measures to improve its fiscal position.

"One of the areas where the pound could benefit more is if the gilt market continues to do well in the coming months and years," said Peter Kinsella, currency strategist at Commerzbank.

"When you have sovereign concerns in peripheral Europe and perhaps even Italy and Spain, the gilt market doesn't look like such a bad place to be."

As a result, he said he expected the euro to slip to around 87.00 pence in a month's time, while a fall to 85.00 pence by the end of the year was possible.

Reuters