LONDON (Reuters) - Britain’s pound looks set to climb against the euro even if the Bank of England turns on its printing presses this week and buys more bonds in an attempt to pump money into the struggling economy.
The safe-haven status of sterling is expected to outweigh concerns that such loose monetary policy weakens a currency. Worries about the euro zone will see to that.
High borrowing costs in Italy and Spain and continued concerns about the viability of Greece remaining in the euro zone mean investors may be willing to ignore the perceived wisdom that central bank asset-buying, or quantitative easing (QE), knocks a currency down by increasing supply in the system.
In fact, with any renewed bond-buying program supporting UK bond prices -- increasing their allure as an alternative to euro zone sovereign debt -- the pound could rise to highs against the euro last seen before Lehman Brothers collapsed in 2008.
“Because the BoE is buying gilts and there are a lot of problems in the euro area the UK is being seen as a safe haven for the bond market,” said Sara Yates, FX strategist at Barclays, who forecast the euro to hit 75 pence in 12 months.
It was trading around 80 pence on Tuesday.
“QE has two faces. It is negative for sterling on interest rate differentials, but also has a positive feed into sterling from the bond market,” Yates said.
Ten-year bond, or gilt, yields reached record lows in early June as investors seeking relative safety switched out of troubled peripheral sovereigns into UK government bonds - and bought sterling against the euro to fund the move.
Normally these low yields would erode demand for sterling-based assets, but many strategists say that as the impact of rate differentials on sterling have been waning since 2008, more QE would be unlikely to weigh significantly on the currency.
Indeed, QE could be seen as a substitute rather than a complement to a further cut in UK rates, already at a record low of 0.5 percent.
Investors could have even more reasons to buy sterling if the European Central Bank cuts rates on Thursday as expected.
Despite this, a monthly Reuters poll of over 60 currency strategists, taken June 29-July 2, showed a consensus for euro/sterling to trade almost flat at 80 pence across the forecast horizon of one-, three-, six- and twelve- months, little changed from the June poll.
But there were several going for a strong rise in the pound, with the highest forecast at around 75 pence.
So far the BoE has announced 325 billion pounds of QE since 2009, and a Reuters’ poll showed policymakers are expected to clear another 50 billion pounds to go this week.
“As everybody now expects QE the announcement effect has already happened so there will be very little negative impact, if any at all,” said Adam Cole, global head of FX strategy at RBC Capital Markets. He also expected the euro to fall to 75 pence, a level last seen in early 2008.
In a case of “sell the rumor, buy the fact”, sterling has tended to depreciate broadly as speculation of more QE mounted, and in a knee-jerk reaction to the announcement. But a BOE quarterly inflation report last year found sterling’s effective exchange rate index rose 1 percent from March 2009 to May 2010 period, when 200 billion pounds was pumped into the economy.
This time around, sterling has managed to hold up reasonably well as expectations of more easing have mounted. The government and BoE have also won plaudits for lending initiatives announced last month, with investors cheered by pro-active steps to protect the economy from the debt crisis.
If all this leads to renewed growth, that too would boost the pound, particularly given the perception in some quarters that the European Central Bank has been struggling to get to grips with the euro zone debt crisis and the bloc’s economy.
“Over the past few weeks there’s been a feeling that anything pro-growth could be positive for the pound which has confused the potential reaction to announcements of more policy initiative,” said Jane Foley, senior FX strategist at Rabobank.
“The market is trying to weigh up supply against growth potential.”
Beyond the euro, the pound could also gain against the dollar if poor U.S. data prompts the Federal Reserve to opt for another round of QE later this year, as some are speculating.
While sterling may not suffer as a result of monetary easing, QE from the Fed is likely to weigh on the dollar as capital outflows from the United States increase, leading to reserve diversification out of the greenback into other currencies, including sterling.
During the first round of Fed QE in 2008, sterling rose from around $1.35 to $1.70 against the dollar, and from roughly $1.45 to $1.63 on speculation of a second bout in 2010.
“If the crisis were to intensify in Europe I think you would see the dollar get a significant lift as being a deep liquid market that could be used as a safe haven,” said Simon Derrick, head of currency research at Bank of New York Mellon.
“But if you saw the response of the Fed to the deepening crisis being ”We need QE3“ I think there could be a turnaround in cable,” he added, saying sterling could hit the mid $1.60s.
It was around $1.57 on Tuesday. The Reuters poll showed sterling weakening marginally to $1.56 in a month and $1.54 in three months before making its way back up to $1.56 by end-June 2013. The highest forecast was $1.67 in a year.
Editing by Jeremy Gaunt.