By Jessica Mortimer
With all news bad news for Britain's battered economy, sterling's six-month slump may have further to go, but charts show any new year slide is more likely to be against the dollar than the euro.
The pound's sudden drop past 90 pence against the euro in December sparked speculation it would soon hit parity against the single currency as the Bank of England slashed the official rate of return for holding assets in sterling.
But the prospect of more European Central Bank interest rate cuts in months ahead have tarnished the euro at a time when U.S. rates have already reached all but zero, bringing a possible quarter-century low for the pound against the dollar into range.
Analysts say the dollar may also benefit from safe-haven and deleveraging inflows as market stress and global economic weakness persist and chart analysis shows investors who are bearish on the pound will move to target the 2001 low against the dollar of $1.3677 instead of parity to the euro.
A break below that would take it to levels not seen since 1985.
"We think sterling will go below these levels ($1.3677) against the dollar in the first quarter," Standard Bank's head of G10 currency research Steve Barrow said.
Merrill Lynch are even more bearish, forecasting sterling at $1.32 against the dollar by June.
Technical analysts at CBCM noted that a fall below $1.4290 would open up a test of a support line at $1.4190/$1.4200, then potentially the 2001 low.
The euro gained more than 15 percent against the pound in December, pushing past the 90 pence mark to a peak of 98.05 pence on Dec. 30, according to Reuters dealing data.
But it has retreated around 5 percent so far in 2009 to hover around 91 pence, backed by growing expectations the ECB will slash rates and estimates that already put it way past fair value as the news on the euro zone economy darkens.
"Sterling is still incredibly competitive. We see fair value for euro/sterling nearer to 70 pence," Investec economist David Page said.
"There is a greater appreciation that what the euro zone is going through is just as bad as everywhere else."
RATE GAP
The jump for the euro against sterling was supported by interest rate differentials as UK rates hurtled towards zero while a more conservative ECB was more reticent about how much and how fast official borrowing costs needed to fall.
Mounting evidence that the euro zone economy is sinking deeper into recession, however, has sparked talk that the ECB will need to cut further and faster than previously thought.
Reuters polling shows analysts expect the ECB to cut its main rate by 50 basis points on Thursday from the current 2.50 percent, taking the euro with it and setting the scene for more easing to come.
But with forecasts for euro zone growth likely to be revised down further, and output and consumer confidence falling like a stone across the continent, analysts say even if the ECB stayed on hold on Thursday it would hurt the euro's prospects.
"We could see investors selling the euro even if they do nothing because doing nothing is the wrong thing, it will get them even further behind the curve," IDEAglobal's Pomery said.
EONIA interest rate futures suggest the market expects rates could fall to 1.25 percent by April, while UK rate futures point to UK rates at around 0.75 percent in the coming months.
The difference is the Bank of England has done much of its work already, cutting borrowing costs by 350 basis points since October to 1.50 percent — their lowest in the bank's more than 300-year history.
"Most of the bad news on the UK economy and the fact that the BoE has cut rates by so much is already incorporated into the pound and we don't expect it to go to parity against the euro," Merrill Lynch G10 currency strategist Emma Lawson said.
Not that the news from the U.S. is much better.
Yet the dollar is backed by its status as a reserve currency for central banks and governments and investors' view of U.S. treasuries as the ultimate safe-haven from stressed markets.
This leaves open the prospect of the pound hitting 24-year lows, analysts believe.
"I do think sterling will do badly against the dollar and we could see new lows," IDEAGlobal senior strategist Maurice Pomery said, forecasting the euro to fall to 85.5 to 86 pence by the end of this quarter.
A dollar below $1.40, he said, was "certainly a possibility".
