Sterling rises

Sterling rose in holiday-thinned trade on Wednesday, but was set for its worst yearly performance against the euro since the single currency's inception almost a decade ago as a bleak UK economic outlook hobbled sentiment. Worries about rising unemployment, deteriorating public finances and aggressive rate cuts have pummelled the pound in recent months.
The 26-year highs hit just over a year ago above the psychologically-key $2 mark are a dim and distant memory. Sterling's near-27 percent slide against the dollar over the year to date would be the sharpest since the gold standard monetary system was abolished in 1971.
The euro, having hit a succession of record highs versus the pound this week, retreated roughly 2 percent by 1251 GMT to 95.44 pence but stayed in sight of Tuesday's record highs just a few pence shy of parity. Moves on Wednesday were sharpened by thin liquidity, dealers said. Analysts said further pound losses were almost inevitable.
"Most of the bad news is already priced in to sterling, and this suggests the euro/sterling move has been a bit overdone. But the overall backdrop is still negative for sterling," said David Powell, G10 currency strategist at Bank of America in London.
"The UK has much larger imbalances than the euro zone in terms of its current account deficit. Also its greater dependence on the financial sector and the higher level of consumer indebtedness suggest the economic recovery in the UK will lag that of the euro zone," he added. Against the dollar, the pound rose 1 percent to $1.4577 on last-minute adjustments in some short positions in the UK currency .
The pair hit 6-1/2 year lows the previous day at $1.4380. This year's sharp falls against the currencies of the UK's main trading partners brought the pound to successive historic lows on a trade-weighted basis, according to daily records kept by the Bank of England going back to 1990.
On Wednesday, trade-weighted sterling was at 74.6, having slipped to 73.3 in the previous session. The euro has soared by over 30 percent against the pound this year, jumping roughly 16 percent so far this month alone. Lower UK interest rates compared with the euro zone have become the latest reason to sell sterling against the euro.
The Bank of England has slashed rates by three points since October to 2 percent, leaving them lower than the 2.5 percent in the euro zone, with more cuts expected in 2009. Markets have fully priced in a cut in rates to 1.5 percent when the BoE meets on January 8, while indicating the possibility of a bigger reduction.
Yields on UK 10-year government bonds have fallen faster than their counterparts in the euro zone, pushing the spread between the two to its narrowest in around six years according to Reuters charts. Economists forecast a sharp contraction for the British economy next year and fear high UK government debt levels will limit room for additional stimulus measures to temper recession.
But some strategists see room for the euro to suffer as the impact of the financial crisis becomes clearer in the currency bloc. "There are just so many issues within the euro zone that no-one wants to talk about. It definitely should not be a strong euro story," said UBS strategist Geoffrey Yu in London.