Sterling falls off monthly highs as optimism proves premature

LONDON (Reuters) - The pound fell back on Wednesday from one-month highs against the dollar and euro as investors realised it was too early to be optimistic about a recovery from the coronavirus crisis.

FILE PHOTO: Pound and U.S. dollar banknotes are seen in this illustration taken January 6, 2020. REUTERS/Dado Ruvic/Illustration

Sterling’s fall against the dollar was driven by a dire global economic forecast from the International Monetary Fund, which diminished risk appetite broadly, boosting the dollar.

The global economy is expected to shrink by 3.0% during 2020 in a coronavirus-driven collapse of activity that will mark the steepest downturn since the Great Depression of the 1930s, the IMF said.

“The dollar is stronger on a very broad basis and that indicates that markets remain quite nervous,” said Thu Lan Nguyen, senior FX strategist at Commerzbank.

“The IMF served as a reminder that it could be a lot worse than what we’ve seen in recent decades and I think the market is still grappling with the extent of this crisis economically,” she said.

“It wasn’t sustainable, this moderate cautious optimism that we’ve seen recently... I think the market’s coming to the realisation that it’s just too early for a sustainable rally.”

A weakening global economy enhances the safe-haven appeal of the U.S. dollar as it is the major currency in global trade and the predominant medium of exchange in world markets.

Versus a broadly firmer dollar, the pound was down as much as 1.5%, at $1.2439, before recovering to $1.2524, down 0.8% on the day erasing Tuesday’s gains. Against the euro, it fell to around 87.12 pence per euro.

The pound has benefited from improved risk sentiment this month as some countries consider reopening their economies, even as experts warn Britain may be on course to become the European country hardest hit by the coronavirus. Sterling reached $1.26 in afternoon trading on Tuesday, its highest since March 13.

But this optimism faded on Wednesday, overtaken by fears about the toll on the global economy.

On Tuesday, Britain’s budget forecasters said the country’s economy could shrink as much as 13% this year due to the government’s coronavirus shutdown - its deepest recession in three centuries - with public borrowing set to surge to a post-World War Two high.

While the pound was driven by global risk appetite affecting the dollar on Wednesday, domestic factors still weigh in.

Brexit discussions restarted on Wednesday, with the UK and EU chief negotiators meeting to agree the schedule for their next negotiating rounds. In contrast to last year, when investors closely watched developments in the negotiations, the announcement had no discernible impact on the pound.

“Brexit discussions can only hurt the pound as they remind the investing public of the unique difficulties that Britain will face on top of the difficulties that every other country faces now,” said Marshall Gittler, head of investment research at BDSwiss group.

Reporting by Elizabeth Howcroft; Editing by Saikat Chatterjee, Mark Heinrich, William Maclean