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Foreign Exchange

Get ready for a pounding: reserve managers unlikely to prop up sterling

Increased concerns about the UK economy have taken a toll on sterling in recent days, but central bank reserve managers are unlikely to ride to its rescue.

“Central banks look at a relatively narrow range of currencies,” says Adam Cole, head of currency research at RBC Capital Markets. “It makes sense that sterling comes on to the radar.” He says the euro has looked less like a reserve currency in recent months and it stands to reason that managers have been pushed by default into considering the pound, and also the yen, as an alternative, as they look to diversify their stockpiles away from the dollar.

Cole says part of sterling’s allure for reserve managers is the coherence among policymakers, with the UK government and the Bank of England seen to be working in harmony to guide the British on to the path of recovery.

In contrast, the eurozone politicians, outside of Germany at least, are at loggerheads with the European Central Bank over its role as the lender of last resort to debt-stricken eurozone economies.

However, traders report that bids in GBPUSD from Asian central banks have been absent in recent days, as the pound started to lose its haven appeal after the UK government admitted its deficit-reduction plan was proving harder than first envisaged.

Ian Stannard, currency strategist at Morgan Stanley, says the lack of reserve manager support for the pound is easily understandable.

He says reserve accumulation is cyclical and hence so too is the need for central banks – particularly in Asia – to rebalance their stockpiles away from the dollar.

“The global slowdown has led to lower accumulation of dollars among central banks,” he says. “This means the recycling flows into the pound and other currencies is also going to drop.”

Stannard believes this leaves the pound vulnerable, as the Bank of England embarks on further quantitative easing in a bid to stimulate the UK economy.

Meanwhile, sterling also looks to have lost some of the support it garnered from the enthusiasm of British politicians to embrace austerity measures.

Signs that the UK coalition government is shifting away from “plan A” in its aggressive drive to rein in spending have been drip fed to the market ahead of Chancellor George Osborne’s half-year autumn statement next Tuesday.

Prime Minister David Cameron said the government’s targets were being threatened by the deteriorating economic outlook, talking of a “chronic debt-driven recession”, and cabinet member Kenneth Clarke warned about the threat posed by the worsening conditions in the eurozone.

It is not a great leap to imagine that the UK government knows something the market does not and, equally, it looks like it is preparing to deliver some bad news.

Expect Osborne to lower growth forecasts and warn that deficit reduction plans are behind schedule.

Expect the pound to lose more of its haven appeal, but don’t expect reserve managers to be buying on the dips.

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