Prospect of looser BoE policy heralds weaker pound

Wed Feb 20, 2013 10:26am EST

Related Topics

* BoE minutes unexpectedly show 3 votes for more QE

* Minutes push sterling to 17-month trade-weighted low

* UK inflation, credit rating worries to spark more losses

* Pound vulnerable to slide towards 2010 low around $1.42

By Jessica Mortimer

LONDON, Feb 20 (Reuters) - Sterling fell sharply on Wednesday and was expected to suffer further losses after the Bank of England appeared closer than expected to loosening monetary policy and in no hurry to curb inflation.

The pound's broad-based losses drove it to a 17-month low against a trade-weighted basket of currencies after minutes from the BoE's latest policy meeting showed outgoing Governor Mervyn King and two other officials voted to relaunch asset purchases under its quantitative easing (QE) programme.

The vote against extending QE was 6-3, closer than the forecast for an 8-1 split.

Policymakers also considered expanding the range of assets they purchased under QE -- typically negative for a currency because pumping more money into the economy increases the supply -- and cutting interest rates.

The minutes compounded pessimism about sterling's outlook, which has also been hit by fears of a downgrade of the UK's triple-A credit rating and a report last week that showed the BoE was willing to tolerate higher inflation over a longer period.

"The BoE have moved the goalposts. They are now saying that despite higher inflation they are thinking of doing more QE, so it is clear sterling has to weaken," said Hans Redeker, head of Global FX strategy at Morgan Stanley.

The pound fell nearly 1 percent against the dollar and the euro, hitting a near 8-month low of $1.5281 while the euro jumped to 87.645 pence, its highest since late October 2011. Sterling's trade-weighted index fell to 78.7, the BoE said.

Sterling's slide left it with the potential for a drop over the next six months towards levels not seen since mid-2010.

"If the central bank continues in this way you have to think that $1.40/$1.42 could come into play within the next couple of quarters," Morgan Stanley's Redeker said.

The BoE also indicated it is prepared to allow inflation to remain above its 2 percent target beyond the two-year horizon outlined in its mandate.

Currency traders often see higher inflation as a signal to buy a currency in anticipation of tighter monetary policy to counteract the prices rises. But a central bank saying it will tolerate higher inflation for longer has the opposite effect as investors fear the value of UK assets will be eroded over time.

The pound has fallen around 6 percent against the dollar and 8 percent against the euro this year, helped as investors scale back exposure to currencies they had bought previously as a hedge against euro break-up.

GEAR CHANGE

"There has been a gear change in terms of the monetary policy framework - the tolerance of higher inflation, the prospect of lower-for-longer policy and the idea that sterling's long-term equilibrium rate is below current levels. That will worry people," RBS's Robson said.

A flexible approach to inflation targeting is also a hallmark of Bank of Canada governor Mark Carney, who will succeed King in July, though Carney's enthusiasm for bond purchases is less certain.

In the shorter term, analysts said the pound could quickly fall toward $1.50, with one trader saying long-term investors had sold the pound in the expectation it would break below last year's low of $1.5234.

"I'm more confident than ever that we get down to our $1.5050 target in quite a short time, in the next couple of weeks," said Paul Robson, currency strategist at RBS.

Selling pressure on the pound against the dollar could intensify if policy meeting minutes, due later on Wednesday, from the U.S. Federal Reserve paint a contrasting picture of a stronger U.S. economy and hint at tighter policy in future.

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