Sterling sank almost 1 percent against the euro on Tuesday, caught up in the fallout of a renewed collapse in oil prices that traders judged would make it hard for the Bank of England to raise interest rates before the end of next year. Action in the options market and bearish forecasts from some major banks suggest sterling may struggle in the early part of a year when Britain debates whether to stay in the European Union.
But the main driver was the prospect that lower oil prices will stay the hand of Governor Mark Carney and colleagues until the end of 2016, at a time when markets are digesting last week's muted euro zone monetary policy easing steps. "Falls in oil prices and commodities prices are good for UK growth, and it also buys the bank more time on inflation," said Lee Hardman, a strategist with Bank of Tokyo-Mitsubishi UFJ in London. "But obviously for sterling that takes away the upside risk of the BoE having to tighten policy after the Fed early next year."
Sterling fell as much as 1 percent to 72.79 pence per euro, its weakest since October 22. It dipped just under half a cent to $1.4996, having fallen as low as $1.4956. Societe Generale and Canada's RBC have both recommended selling sterling in the past week, the French bank predicting the pound could fall to as low as $1.30 if voters opt to leave the European Union in a referendum. Hardman said that if sterling breached $1.49, its next targets would be this year's lows around $1.45.
Prime Minister David Cameron has promised to renegotiate Britain's EU ties and then hold a referendum on whether to remain a member by the end of 2017 but there has been some speculation the referendum may come next year. Richard Benson, co-head of portfolio investment at currency fund Millennium Global in London, said a volatile end to the year was bearing on the pound, given some of Britain's longer-term issues with high twin external and budget deficits.
"The structural outlook for sterling is particularly weak and at the turn of the year that tends to be the focus," he said. After the tumultuous moves following last week's European Central Bank meeting, some analysts had pointed to a chance the BoE's minutes on Thursday would take a slightly more hawkish tack than its recent rhetoric.
Even if money markets have pushed expectations for a first rise in UK interest rates far out into next year, the BoE is still seen as the most likely to follow in the footsteps of the US Federal Reserve. Constantin Bolz, Director for FX Strategy with UBS in Zurich, said the pound was still an attractive currency. "There are a few domestic cost pressures which should come to bear on UK inflation and that should make them a candidate for a rise in interest rates next year, even if Brexit may prove a problem," he said.
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