British policymakers sending sterling lower

IT WAS all go on the City&rsquo;s currency trading floors yesterday morning. What sparked the furious trading was Bank of England governor Mervyn King hinting to the Parliamentary Treasury Select Committee that the Bank would implement a cut in the interest rate that banks receive on their deposits with the Bank of England. <br /><br />Immediately, the markets realised the negative knock-on effect that this would have on sterling through market interest rates, which could undermine the currency until the October policy meeting when the Bank would announce major policy changes. <br /><br />The pound fell through the floor, losing nearly one percent of its value in the day, much of it in 20 minutes. While this was bad enough, forex traders should be aware that it is not the whole story. The rest of what King had to say could actually damage sterling even more.<br /><br />Markets are currently expecting the Monetary Policy Committee (MPC) to hike interest rates as early as the first quarter of next year, but King&rsquo;s prediction that inflation will remain below the Bank&rsquo;s 2 per cent target over the medium term means that the Bank is going to have to continue very loose policy much longer, points out Ian Stannard, senior currency strategist at BNP Paribas. <br /><br />Also negative for sterling was prime minister Gordon Brown&rsquo;s speech to the Trades Union Congress (TUC) yesterday afternoon, in which he said that Labour would make cuts in public spending to address a growing budget deficit that is one of the largest in the major economies.<br /><br />Politicians from all three major British parties outlined their plans for future fiscal policy yesterday and all called for cuts to public spending to bring the budget deficit &ndash; which the chancellor Alistair Darling forecasts to reach &pound;175bn this fiscal year &ndash; under control.<br /><br />&ldquo;The combination of tighter fiscal conditions and loose monetary policy is a very negative mix for sterling,&rdquo; says Stannard &ldquo;It has broken back through the $1.645 level and this opens up the move back toward the $1.60 mark.&rdquo; <br /><br />The pound is now at risk of a further move lower and this will start to unfold very quickly over the course of this week.<br /><br />Foreign exchange traders should therefore be anticipating another move lower in both sterling-dollar and sterling-euro currency pairs in the medium-term as they start to price in fully the full extent of what Mervyn King has just announced.<br />