Sterling is Really a Pound

Sterling was the market's darlings over the last five months and was the best performing G7 currency. Between March 10 and Aug 5, sterling appreciated by more than a fifth against the US dollar and by 10% against the euro. However, since the BOE unexpectedly extended its quantitative easing, sterling has been pounded. It is the worst performing major currency since Aug 5, losing a little more than 4% against the dollar and almost half as much against the euro.

Most of the time, the market demands a higher interest rate from the UK than the euro zone. But this is not the case at the moment. Looking at the Dec 09 short sterling vs the Dec 09 Euribor futures contracts, which serve as a proxy for short-term rate differentials and are the key to forward prices, UK rates have slipped below euro zone rates.

This happened briefly in late May and roughly coincided with a euro bounce against the pound. It also took place at end of last year, and then too the euro outperformed sterling.

This interest rate development, coupled with the news stream, which included renewed weakness in the Rightmove, house price index, and the unwinding of risk trades, warn that sterling is particularly vulnerable against the euro. A base in the cross has formed in recent sessions near in the GBP0.8560-70 area. A move now above GBP0.8650 would likely compel at test on GBP0.8700, but there is potential GBP0.8800 and then GBP0.8950.

The anticipated weakness of sterling against the euro does not necessarily mean that it will also decline against the dollar, but at this particular time, it looks like that will be the case. Technical indicators for the pound are poor and it support against the dollar is not to be found until closer to $1.60.