Sterling falls after Moody's ratings cut

Monday 25 February 2013 17.08
Sterling set to be hit hard after UK credit downgrade
Sterling set to be hit hard after UK credit downgrade

Sterling has fallen to its weakest since July 2011 against a basket of major currencies, the first trading day after Moody's stripped the UK of its Triple-A credit rating.

Further falls in the pound were expected in the coming weeks given the grim outlook for the British economy and the prospect of more monetary easing.

There is also growing evidence that the Bank of England is comfortable with a falling currency as it seeks to rebalance the economy and encourage exports.

"Investors will remain nervous about the pound," said Ian Gunner, portfolio manager at Altana Hard Currency Fund.

"Monetary policy will now be more significant and the minutes last week showed more easing could be on the way."

Financial markets had been braced for a rating cut for some time because UK growth was sluggish and finance minister George Osborne missed a series of debt-reduction targets.

It had, however, been expected to come after the budget, on 20 March.

Political pressure was building on Mr Osborne to change course and do more to foster growth.

While analysts expect his budget to stick to deficit-busting measures, tension within the ruling coalition could undermine the pound in coming weeks.

Sterling fell as low as $1.5073, its weakest since mid-July 2010.

Traders said sellers would re-emerge if sterling showed any signs of rebounding towards $1.53.

Its trade-weighted index hit a 19-month low of 78.10. The euro rose 1.6% to a 16-month high of 87.98 pence.

The pound has lost nearly 7% against the dollar and 7.3% against the euro this year.

The options market showed investors were expecting sharper moves in the pound.

One-month euro/sterling implied volatility - a measure of future price swings - hit a 14-month high of 10.1% while one-month sterling/dollar volatility was at its highest since June.

Investors were increasingly buying options betting on longer-term weakness in the pound, traders said.

Meanwhile the euro has pared gains against the dollar and the yen after an Italian election projections showed former prime minister Silvio Berlusconi's conservative bloc leading in the Senate, raising the spectre of deadlock in the country's parliament.

The credit downgrade compounds pressure on the pound that emerged last week after minutes of a BoE policy meeting showed officials, including Governor Mervyn King, edged closer to another round of the bond-buying programme that pumps more money into the economy - a policy known as quantitative easing.

The bank's quarterly report earlier this month also said policymakers were prepared to tolerate higher inflation to support growth.

"(The rating cut) reinforces the perilous economic position the UK is in," said Kathleen Brooks, research director at Forex.com.

"This downgrade may fuel more speculation that QE will be re-started later this year. This is pound-negative for the medium term and we could see sub-$1.50 in the near term."

Such monetary easing is seen as hurting a currency as it involves the central bank printing more money to buy bonds. That increases the supply of the currency and erodes its value.

Analysts said that by tolerating higher inflation in the coming years, real or inflation-adjusted returns for investors would diminish, making the pound and UK assets less attractive.

Data from the Commodity Futures Trading Commission showed more speculators building bets against the pound in the week ended 19 February, after they flipped from bets in favour of the currency a week earlier.

Bets against the pound may have some way to go, with net short positions just a fraction of the nearly 80,000 contracts in place when sterling fell to below $1.45 in May 2010.