Not so sterling?

While the bullish forces seized control of the British pound (a.k.a. sterling) in mid-July, many market watchers believe the corrective upmove has run its course. After hitting a high vs. the U.S. dollar around $1.85 in early September, expectations of renewed easing by the Bank of England (BOE) in 2006, slowing UK growth prospects, and overall strength in the U.S. dollar could stand in the way of further sterling gains.

In early August, the BOE cut rates for the first time in two years, bringing the benchmark interest rate down to 4.50 percent. The BOE pulled the trigger on an easing in the wake of considerable softness in the growth picture and a cutback in domestic consumer spending. The inflated values of the pound, along with high interest rates, had a negative impact on the economy.

“The economy was slowing significantly,” notes Brian Dolan, director of research at Gain Capital. In2004, the UK churned out growth numbers around 3.2 percent. However, first quarter 2005 gross domestic product growth dropped to 1.5 percent.

“The primary motive for the [interest-rate] cut seemed to be to shore up confidence and peremptorily ward off a deeper correction in personal spending growth,” says Paul Guest, head of Economy.com’s European research team. Guest forecasts real UK GDP growth at 2.1 percent for 2005. However, analysts note that the decision to cut rates was not unanimous — the vote was a narrow 5 to 4, with BOE Governor Mervyn King in the minority. Because of the divided outlook of the Monetary Policy Committee (MPC), some analysts say another rate cut may not occur this year.

Next year? Looking into early next year, however, some are calling for a cut as early as January.

“Once it’s clear that the domestic economy has stalled and once slackening capacity constraints have eased price growth, the Bank will cut again,” Guest says.

Guest believes this BOE easing cycle will bottom out at 4 percent in mid-2006.

The bottom line is that the divergence between looser UK and tighter U.S. monetary policies should put downward pressure on the sterling vs. the U.S. dollar.

“The BOE should be heading lower and the FOMC should be raising rates, which means it should be a good time to sell the pound,” says Tim Mazanec, senior foreign exchange strategist at Investor’s Bank & Trust.