Sterling bears caught short, but pound still vulnerable

Peter Garnham
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Mervyn King, the outgoing governor of the Bank of England, put a temporary halt to the slide in the pound on Thursday, but the currency still faces challenges in the weeks ahead.

King, perhaps unsettled by the accusations that the Bank was actively talking down the pound and had abandoned its inflation target, said in a TV interview that sterling, which has dropped over 6% on a trade-weighted basis so far this year, was now fairly valued.

“We are certainly not looking to push sterling down,” King said, adding that the pound was now at levels seen immediately after the financial crisis.

For those concerned that the central bank’s Monetary Policy Committee was now less concerned over price pressures in the UK economy, he said the bank was determined to bring inflation back to target.

“I am quite confident that over the next two to three years, the Monetary Policy Committee will pursue the policies needed to achieve just that,” he said.

The comments sparked a reaction in the currency market, with GBPUSD rallying from $1.49, just above the two-and-a-half-year low of $1.4832 it earlier in the week, to above $1.51.

Much of that, however, was triggered by a squeeze on short positions in the pound, rather than any shift in sentiment of the UK economy, or its ability to avoid a triple dip recession without further stimulus.

As the chart below shows, positioning data from the CME indicates that short sterling positions among speculative investors were at multi-month highs ahead of King’s comments.


 Sterling short positions at multi-month highs

As Arthur Rodier, strategist at BMO Capital Markets points out, it has been a one-way street for GBPUSD this year, falling from $1.6380 at the start of January to the $1.4832 low earlier this week.

“The domestic and fundamental backdrop remains negative and favours continued sterling weakness in general, but the technical picture is starting to suggest this current down leg is beginning to get overextended and that a long overdue correction may be in the making,” he says.

“Short sterling is a very crowded trade at the moment so there is definitely some potential for a pronounced short squeeze but I would look for $1.5250-$1.5550 as capping advances from here and serving as sell zone for the next leg lower.”

So the timing of King’s intervention helped trigger a correction in the market, and does not suggest that sterling has now found a long-term base.

Investors, therefore, will still be looking to sell the pound on any sign that the Bank will loosen monetary further in a bid to stimulate the UK economy.

That is especially true given King voted for an extension of the Bank of England’s asset purchasing scheme at the MPC’s February meeting – the release next week of the minutes of March’s meeting will see if he stuck to that view.

If it turns out that King did change his view, it may give sterling bears pause for thought.

However, they are unlikely to put too much weight on the outgoing governor’s position, and his seemingly new found belief that the pound has fallen far enough, if it contrasts with continued weakness in the UK economy.

“Policymakers rarely have the ability to make currencies go up and down as they wish, and while we do believe that sterling will recover over the long haul, we think this can only come about from improving fundamentals – not King’s pleas for the selling to stop,” says Steve Barrow, head of FX strategy at Standard Bank.

Sterling’s sell-off may have temporarily run out of steam, but the currency is not out of the woods.