Sunday 15 November 1998
"We expect sterling to resume a degree of weakness in the short term," said Jonathon Griggs, head of foreign exchange research at ING Baring Securities. "The defining event of next week will be the Federal Reserve decision. If it comes through with a cut, and if next week's UK reports are weak, we could see renewed expectations that the Bank of England will cut rates in December."
Sterling rose 1.4 per cent to a six-week high against the mark last week as investors scaled back expectations for a December rate cut by the Bank of England after the bank's quarterly inflation report raised inflation concerns. The pound was trading on Friday at DM2.8108, up from DM2.8001 on Thursday. It was at $1.6645 from $1.6607.
The Bank of England cut its benchmark rate half a point to 6.75 per cent the week before last, the second cut within a month, and more than expected. The next rate-setting meeting takes place on 9 and 10 December.
In last week's inflation report, the central bank said higher wages would nudge inflation above its 2.5 per cent target during 1999 before falling back to target in 2000. Sterling jumped along with short-sterling yields, suggesting investors thought they'd been expecting too much in the way of rate cuts.
The implied yield on the December sterling interest-rate futures contract, a measure of UK rate expectations, rose 2 basis points to 6.80 per cent on Friday. That yield rose 12 basis points the previous week and, at just 14 basis points below current three-month borrowing rates, suggests fading expectations rates will be cut again this year.
"There's probably nothing left in the way of lower rates this year," said Kevin Adams, a strategist at Barclays Capital.
Reports this week, though, could change investors' views yet again. Retail prices minus mortgage interest payments set for release on Tuesday, is forecast to slow to 2.4 per cent in October from 2.5 per cent in September.
October retail sales are expected to rise 1.6 per cent, down from September's 3.7 per cent gain. On Friday, a gross domestic product report should show that growth slowed to an annual 2.5 per cent in the third quarter, from 3.0 per cent the quarter before.
"Whether rates are cut again this year or not isn't really important," said Paul Causer, at Perpetual Investment Management. "The point is rates have to go much lower next year."
Mr Causer said rates could fall "to 5 per cent or even below" in 1999, which suggests "sterling will continue trending lower". He expects the pound to fall to the equivalent of DM2.70, and to $1.60, in the next three months.
A US rate cut could also push the Bank of England to lower rates again this year since it would suggest that the threat of a global economic slowdown hasn't receded.
A survey of economists at the 32 primary dealers, which deal directly with the Fed's securities trading desk, found that 30 expect the Fed to lower rates for a third time in eight weeks when they meet on Tuesday. Two foresee no change.
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