The pound’s rally stalls

Kathleen Brooks
FOREX traders diligently looking at the cable chart in recent weeks might be rather gloomy about the outlook for the pound. Yesterday it broke below a key level against the dollar, which suggests there could be further weakness to come.

That level was $1.5490, the 200-day moving average, which indicates that sterling has lost its momentum after a summer rally lasting nearly three months. Now we are at a pivotal point – can the pound bounce back, or will it drift ever lower and, like the change in the London weather, suggest that summer is finally over?

Those in the camp who believe the pound has run out of steam say that sterling’s rally was fairly fragile to start with. It began after the general election and seems to have been driven by the fairly harmonious Liberal-Conservative coalition. However, the markets are back focusing on the public sector spending cuts, which are just around the corner. For example, the Comprehensive Spending Review, which will be released in October, could weigh on sentiment as the reality of the cuts sets in.

Added to this are fears about growth. Although the UK had a strong run in the second quarter, many doubt that it can repeat this feat as the global economy starts to moderate. If growth stalls, then this just further reduces the chances of an interest rate hike from the Bank of England. The sensitivity of the pound to interest rate expectations was in full show yesterday. New Bank member Martin Weale warned that the UK faced a serious risk of falling back into recession and that growth forecasts for this year were too optimistic. This sent the pound in a bit of a tail spin.

“We expect sterling to come under pressure as renewed UK data weakness is likely to see the balance of views in the Bank of England shift back towards the dovish side,” wrote analysts at BNP Paribas in a note to clients yesterday. They expect sterling firstly to fall to $1.5335 and, if it breaks below this level, to carry on down to $1.5125, 2 per cent lower than it is now.

This change in sentiment is a key shift for the pound. During the summer months sterling was actually trading a bit like a safe haven. This was mostly because of fears about a slowdown in the US, which contrasted with the strength of the economic data coming out of the UK.

Michael Hewson from CMC Markets says that if the pound is to restore its upward bias, it will need to bounce back even higher to the $1.57 level. That is a good way to sum it up for the pound right now. It’s going to have to work even harder and economic data will have to surprise even more on the upside for sterling to regain its footing, especially against the traditional safe-haven of the dollar.