Sterling slipped against the dollar on Tuesday on divergent expectations for monetary policy, with investors increasingly betting US interest rates could rise by year-end while British rates may be cut again. With London markets closed on Monday for a public holiday, Tuesday marked the first full day of trading there since US Federal Reserve Chair Janet Yellen and Vice Chair Stanley Fischer left the possibility of a near-term rise in US rates on the table, boosting the dollar.
Investors are now pricing in around a 55 percent chance of a rate hike by the end of the year, according to CME FedWatch. In contrast, the Bank of England is expected to cut its record-low interest rates further after cutting them this month and relaunching a quantiative easing programme - creating new money to buy assets - in an effort to boost the economy following Britain's vote to leave the European Union.
Sterling hit a three-decade low of $1.2798 in July in the wake of the vote for Brexit. It has since recovered about 2 percent, but that still leaves it around 12 percent lower than where it was before the June 23 referendum on EU membership. Though data covering the months since vote for Brexit suggests the economy has held up reasonably well, investors are anxious that foreign inflows of capital will dry up, leaving Britain's already huge current account deficit vulnerable to further widening. And much uncertainty remains over the deal Britain will strike with the rest of the EU.
"Sterling will weaken over the course of the year, because there is that uncertainty vacuum that is not going to be filled any time soon," said Bank of New York Mellon currency strategist Neil Mellor. "The Bank of England is going to find it very hard to back out from implementing further cuts in rates because if it does, it risks sending sterling sky-rocketing higher and then its competitive boost ... would vanish overnight, and that would set UK PLC back a fair bit."
Sterling has fallen more than 1 percent against the dollar since Friday's comments from Yellen and Fischer at a meeting of global central bankers. On Tuesday it traded 0.1 percent lower on the day at $1.3090, though it was up 0.3 percent against a broadly weaker euro at 85.13 pence.
Data released on Friday showed sterling net short positions hit a record high of 94,978 contracts in the week to August 23. The pound's net short position has hit record highs for six straight weeks. "The retreat back towards the $1.30 level captures our view that part of the squeeze higher in the pair had been due to a softer dollar," said ING currency strategist Viraj Patel. "The BoE's easing bias, softer UK economic data and sterling's role as a funding currency will all keep the bearish ... momentum in place."
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