Sterling edged down towards three-week lows on Thursday on the view that the Bank of England may soften the tone of its previously confident outlook on the economy after some tepid survey results this week and a selloff in global markets.
In late January, Bank of England Governor Mark Carney painted a fairly optimistic picture of the economy, leading some analysts to pencil in a second interest rate hike as early as May after the bank raised rates in November for the first time in over a decade.
But lukewarm surveys this week and falling house prices have raised concerns that the bank may temper any comments after its policy meeting on Thursday about potential rate hikes with a cautious tone. That could lead to some unwinding of long sterling positions that have increased substantially in recent months.
"Our positioning tracker suggests that investors are most long sterling out of any of the G10 currencies, which is a risk should an unexpected event shift sentiment significantly," Morgan Stanley strategists said in a daily note. Broader positioning on sterling according to futures contracts is at its highest in 3-1/2 years, while some large funds have increased bets, expecting its undervaluation to correct eventually.
Sterling slipped a quarter of a percent to $1.3852, a whisker away from a three-week low of $1.3838 hit on Tuesday. Investors remain on edge after the latest selloff in global equities, as a burst of volatility hit long positions amid broader concerns that rising interest rates around the world could begin to reduce liquidity.
The BoE raised borrowing costs for the first time in more than a decade in November, reversing a cut made in 2016 after the Brexit vote shock and taking them back to 0.50 percent. Futures market rates suggest there is less than a 50 percent chance of another rate hike by May. The BOE also releases its inflation report on Thursday. Though financial markets don't expect any change in policy today, markets will be closely watching for the vote and accompanying comments.
BOE Governor Mark Carney has said that wage growth is finally picking up and that the focus of the BoE is shifting back to tackling above-target inflation. Analysts reckon any further positive forecasts on the economy might prompt investors to add positions in the undervalued currency. ING analysts predicted more sterling upside in the medium-term, having revised their forecast for the end of this year to $1.45.