LONDON, Feb 25, (RTRS): Sterling fell to its weakest since July 2011 against a basket of major currencies on Monday, 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, the prospect of more monetary easing and 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 March 20.

Political pressure was building on 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 percent to a 16-month high of 87.98 pence.

The pound has lost nearly 7 percent against the dollar and 7.3 percent 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 percent 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.
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 (QE).

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 Feb. 19, 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.

Britain’s loss of its triple-A credit rating from Moody’s added to the pound’s woes on Monday, helping send it lower against both the dollar and euro, but UK bonds, underpinned by the central bank, recovered quickly.

The pound only fell moderately, but still hit lows against the dollar not seen since July 2010. The euro rose against sterling to its highest since October 2011.

Ten-year British bonds, or gilts, initially sold off sharply but later regained most of their losses. British stocks were broadly higher, lifted in many cases by prospects of greater exports from a weaker currency.
The impact was relatively muted because markets have already been reacting to the conditions that prompted Moody’s to act — particularly an economy teetering on the brink of a third recession in four years.

The pound was under heavy selling pressure last week after the Bank of England made clear that the currency could have further to fall, and that it is prepared to tolerate the impact this would have on inflation.

Bank of England Governor Mervyn King’s support for more bond buying, or quantitative easing (QE), has also been undermining sterling strength because it implies more potential money printing.

“Realistically this is not a sudden smash down but a continuation of a move that’s been under way all year,” Andy Chaytor, London-based macro strategist at Nomura, referring to the reaction to the downgrade.

“The stars have aligned in terms of fiscal policy, central bank policy — being seen by the market to be allowing higher inflation — and then you get a downgrade as well,” he said.

Sterling hit its two-and-a-half year low of $1.5073 during Asian trading hours, and fell to its 16-month low against the euro of 88.15 pence later.

It is now around 7 percent weaker against both the dollar and the euro than it was at the start of the year.
In government debt markets, 10-year gilt yields jumped at the start of trading by 6 basis points to peak at 2.175 percent — their sharpest intraday price fall since Feb. 13. But later they were just 3 basis points up on the day at 2.14 percent and outperforming benchmark German Bunds.

The news last week that King and two other policymakers favoured more bond purchases has lifted demand for gilts, even if the inflation outlook weighs on them and some investors think they offer poor value.

“The (bank) minutes (last week) were pretty important because they gave the market a life-line that more QE might be coming,” Chaytor said. “If we hadn’t had that, things might have been a bit rockier.”

Some investors said Chancellor of the Exchequer (finance minister) George Osborne should not draw too much comfort from the muted initial reaction in markets to the loss of a triple-A debt rating he had repeatedly vowed he would protect.

Toby Nangle, a fund manager at Threadneedle Investments, said low gilt yields were driven by loose central bank policy, and did not reflect any sense that Osborne’s belt-tightening drive meant Britain was in better shape than more heavily indebted euro zone countries.

“The government has favourably contrasted these low government bond yields with high yields in a number of euro zone countries that are as fiscally troubled as the UK. But this comparison is without base and is disingenuous,” he said.

“Yields are low because the market believes that(interest) rates will remain low, and because of the Bank of England’s policy of quantitative easing,” he added.

The next test of investor sentiment will come later this week, and possibly as early as Tuesday, with a sale via syndication of around 3.8 billion pounds of 2052 index-linked gilts