Pound poised for new rally if BoE holds fire on QE
* Sterling set for more gains if BoE does no QE on Nov. 8
* Biggest gains may be vs euro, Swedish crown, Canada dollar
* QE expectations reduced since last week's strong UK GDP
By Jessica Mortimer
LONDON, Nov 1 (Reuters) - Sterling, a favoured shelter from euro zone stress, may be set for a new rally if the Bank of England holds off from more quantitative easing next week after strong UK growth figures.
If the BoE refrains from further asset purchases, which the market had been expecting until last week, it will contrast with some other central banks which look more likely to loosen monetary policy due to a recent weakening in their economies.
Data last week showed UK third quarter output grew 1 percent, far more than forecast. The pound rose as investors saw less chance the BoE would ease.
It hit a three-week high against the euro and multi-month highs against the Japanese yen, Swedish crown and Canadian dollar.
Except against a broadly weaker Canadian dollar, sterling has not revisited those highs since as doubts crept in about whether the UK can sustain solid growth, especially as the latest data was flattered by a boost from the London Olympics.
"If we don't see more QE it would be a boost for sterling because there will be some investors out there who have priced it in," said Bank of New York Mellon currency strategist Neil Mellor.
Before the GDP data most in the market expected more QE from the BoE's Nov. 8 meeting. But only 40 percent of economists polled by Reuters this week see this happening.
QE - effectively printing money - is usually considered negative for a currency since it increases the supply. But the pound has stood its ground despite recent bouts of QE due to safe-haven flows out of the euro prompted by the debt crisis.
While it should gain if the BoE keeps policy on hold, a sustained rise will depend on the UK recovery continuing into the fourth quarter.
COMPARING MONETARY POLICY
"If the BoE is becoming less dovish then sterling is likely to benefit most against currencies where we see changes in the opposite direction, where central banks are becoming more dovish," said Valentin Marinov, head of European G10 currency strategy at Citigroup.
He sees an increased risk of a rate cut by the European Central Bank after recent weak euro zone data, and said the euro could fall to 79 pence. It hit a low of 80.02 last week.
Commodity Futures Trading Commission data shows speculators held a net long position in the pound in the week to Oct. 23. But Marinov said Citi's indicators suggest investors have pared long sterling positions since mid-September.
This should allow for further sterling gains as investors re-establish long positions, especially against the euro.
Citi last week recommended clients buy sterling against the Swedish crown, citing the lower chance of QE in the UK and a cut by Sweden's central bank, the Riksbank, to forecasts for its future interest rates.
Citi expects sterling to rise to 11.00 crowns, compared with around 10.75 crowns currently and Friday's peak of 10.8593.
Differing monetary policy expectations could also see the pound gain versus the Canadian dollar and the yen.
The Bank of Canada last week said rate hikes have become "less imminent" while there remains a risk Japan's authorities may intervene to stem gains in the yen.
"If the Bank of Canada is even seen as potentially contemplating moving away from its mild tightening bias then the Canadian dollar would continue to underperform and sterling/Canadian dollar would move higher," said Audrey Childe-Freeman, head of foreign exchange strategy at BMO Capital Markets.
The pound may also gain against the dollar, although the impact of the Sandy storm and uncertainty about the U.S. presidential election may send investors flocking to the perceived safety of the U.S. currency.
"If people are going to be persuaded to buy dollars then it would be far better to take a long sterling position against the euro in that environment," said Jane Foley, senior currency strategist at Rabobank.
Equally, better news on Spain or Greece could limit the pound's gains against the euro.
"A more supportive outlook for the euro and I'd go long sterling/dollar and target $1.65 ... If the euro disappoints a little, if Spain is still not going through the (aid) request programme then the sterling strength story is through euro/sterling," BMO's Childe-Freeman said.
But concerns remain that the UK's recovery may be short-lived and this could hamper sterling. There is still a risk of more QE - if not in November then in December or in early 2013.
"The backdrop of a fairly weak economy is going to continue. The UK is potentially in recovery mode but these (GDP) figures are a red herring," BNYM's Mellor said.
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