Sterling jumped to a 10-day high against the dollar on Thursday as year-end position adjustments led to a broad sell-off in the US currency, with thin trading sparking exaggerated price movements. The pound also extended gains against the euro as month- and year-end flows as well as technical factors supported the currency, helping lift sterling's trade-weighted index to a 10-day high.
Many analysts believe sterling could come under pressure early in 2010, however, due to jitters about its huge debt burden ahead of a UK general election, although the currency is broadly seen as undervalued on a longer term horizon. "Over the next couple of months the market will have to take into account the potential implications of the election and this could prove negative for the pound," said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ.
Investors are concerned about the possibility of the election resulting in a hung parliament, which may make it difficult for the government to take steps to reduce the UK's ballooning budget deficit. At 1324 GMT, sterling was up 1 percent against the dollar at $1.6225, just shy of the session's 10-day high of $1.6236. The euro fell 0.6 percent to a low of 88.66 pence, while sterling's trade-weighted index rose to 80.5, also its strongest in 10 days.
"This is just year-end trades. Trade is so thin it only takes a few orders to go through to cause a big movement," said UBS currency analyst Geoffrey Yu. Technically, sterling's rise against the dollar on Thursday appeared to mark at least a short-term positive reversal for the UK currency, which climbed back above its 200-day average (at $1.6062) following positive 14-day momentum and relative strength index (RSI) divergences at Wednesday's low.
A bullish crossover by the daily Moving Average Convergence Divergence oscillator - used to gauge turning points in trends - and a bullish engulfing pattern on the daily candlestick chart, were further technical signs of a positive reversal.
The rebound broke the 23.6 percent retracement of sterling's drop from its November peak, making its next technical target the 38.2 percent retracement at $1.6230, followed by the 100-day average at $1.6338. Sterling's trade-weighted index has recovered by around 9 percent over 2009, although this must be set in the context of a 24 percent fall in 2008, meaning the currency remains historically very weak.