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After sterling’s rally, investors are playing a waiting game

FOREX markets gave a cautious welcome to George Osborne’s emergency Budget measures yesterday, with sterling rallying to highs of $1.4851 and €1.2081. However, the pound still failed to make up Monday’s losses against the dollar, reflecting a widespread wait-and-see approach as analysts work through the details of the Budget and watch for its impact on growth.

Reactions were mixed as to whether the Budget delivered a tougher or softer approach than expected, with the only consensus being that there were no major surprises. As a result, for the short-term, Mark Deans at forex specialist Moneycorp says: “It’s possible that there’s no energy left in the sterling rally because the austerity measures have already been priced in. It may just trade sideways after some movement today.”

The medium- to long-term outlook primarily depends on the Budget’s effect on the economy as a whole, but in the short-term most analysts expect to see the pound gain gradually against the euro. Foreign Currency Direct’s Stephen Hughes says: “The chancellor’s tough talk and confident delivery has done much to reassure investors and as a result we can expect to see the pound enjoy some modest short-term gains.”

The prospect of continued loose monetary policy, however, brings with it the possibility of some downside movement. Investec Treasury Solutions’ Lee McDarby warns: “There is a risk of a short-term sterling sell-off associated with a weaker growth outlook and softer interest rate projections.” Even so, the year should see steady gains against the euro. For the summer, Hughes sees sterling hovering close to €1.26 while McDarby puts it a little higher at €1.28 for the end of 2010.

But there is much less certainty over sterling’s trajectory versus the dollar, which benefits from perceived safe haven status. While investors have expressed initial confidence in Osborne’s plans, concerns remain that the Office for Budget Responsibility’s (OBR) growth estimates are still inadequate. Regarding the OBR’s downwards revision of Treasury projections, Ian Stannard at BNP Paribas nonetheless says they remain too high.

Even so, with the US far from regaining rude fiscal health itself, sterling could still be a viable option for traders looking for somewhere to put their money. CMC Markets’ Michael Hewson forecasts that if sterling stays above a seemingly resilient level of $1.4440, it could well rise to $1.50 by the end of the year. On the downside, he predicts a risk of falls to $1.44 if we see it drop below $1.4680.

Either way, Hewson says: “It’s going to be a bit of a choppy ride.” Despite the long-term necessity of tough action on the deficit, with a Vat rise to kick in in January and as yet unspecified cuts of 25 per cent in most government departments, the country should brace itself for a patchy return to growth. FxPro analysts say that based on comparisons to similar periods of fiscal contraction, “it’s more likely than not that we do see at least one negative quarter of growth in the coming year”. Expect to see sterling wobbles further down the line.

A strong sterling is not, of course, universally welcome. Selftrade advisor Stephen Barber comments: “A sustained increase in sterling will make UK borrowing cheaper but also increase the cost of our exports – so far leading recovery.” So sterling dips could give occasional boosts to growth, which would in turn push the pound back up.

With Osborne pursuing a tough line rhetorically, FxPro highlights that “the bigger picture is dependent on delivery. The details... have yet to be thrashed out for the October spending review”. So while yesterday’s Budget was a strong start and a boost for sterling, traders should wait to see whether the measures have staying power and what their impact on economic activity will be.