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Pound to make modest gains

Source: Reuters - Tue 9th Feb 2010

The pound will make modest gains against the dollar and the euro this year but will be held back by the potential drag from rising interest rates on an already weak recovery, a Reuters poll showed on Wednesday.

Median forecasts from the monthly poll of over 60 analysts taken this week put the pound at $1.60 in one month, unchanged from the $1.60 it was trading at earlier on Wednesday and down slightly from the $1.62 predicted last month.

The poll predicted cable at $1.62 in six months and then nudging up to $1.64 in 12 months. This compares to six- and 12-month forecasts of $1.63 and $1.65 in January's poll.

"We expect current negative sentiment on cable to ease as risk appetite will resume throughout the year" said Roberto Mialich at UniCredit MIB.

"A BoE rate hike in Q4 should limit the impact of higher interest rate in the U.S. during the second half of the year."

The Bank of England slashed interest rates to an historic low of just 0.5 percent and is expected to hold them there when it meets on Thursday and through to the last quarter the year, from where they will slowly climb.

The BoE has been injecting billions of pounds directly into the money supply through its quantitative easing programme to boost a struggling economy but it is seen capping QE at the 200 billion pounds already announced.

Britain faces a general election by June, with a growing prospect of a hung parliament, while markets and credit ratings agencies say the country must swiftly address a deficit set to hit 12.6 percent of GDP this year. 

The British economy grew a lacklustre 0.1 percent in the fourth quarter of 2009, having shrunk for six quarters in the deepest recession since the Second World War. The U.S., by contrast, had a buoyant fourth quarter.

"Superior U.S. versus UK GDP growth differentials, UK election uncertainty and the risk of a UK ratings downgrade cast a dark cloud over the GBP/USD outlook for the next few weeks and months" said Kenneth Broux at Lloyds TSB.

The uncertainty in the market meant range of forecasts remained wide, from $1.41 to $1.93 in a year, but all a long way from the $2.10 it was toying with two years ago and the 23-year low of $1.35 hit early last year.

Sterling volatility against the dollar was seen falling over the coming month. Analysts say the divergence of forecasts in Reuters currency polls offers a leading indicator of exchange rate volatility in the following month.

Against the euro the pound was also seen making only modest gains as both economies recoveries gather steam.

The currencies nearly reached parity at the end of 2008 but cross rates calculated by Reuters show it trading at 88 pence in one and three months and then strengthening to 85 pence in a year. That is stronger than predicted last month and compares to the 87 pence it was at earlier on Wednesday.

"The fact that we expect EUR-GBP to decline largely reflects our view that the euro is still more relatively overvalued, rather than a fundamental belief in the UK outlook" said Meng Jiao at BofAML.

The 16-nation bloc's economy escaped from its worst recession a quarter earlier than Britain but is seen growing at the same pace of 1.2 percent this year.

Data released earlier on Wednesday showed both the euro zone and Britain's dominant service sectors expanded at a slower pace in January than in the previous month.

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