New BoE chief's "forward guidance" could drive pound lower

06/28/2013

* Anticipation rates will stay low to weigh on sterling

* More betting through options on sterling weakness

* Some banks expect pound to drop below $1.50

By Anirban Nag

LONDON, June 28 (Reuters) - Mark Carney's arrival as Bank of England governor on July 1 could herald further weakness in the pound as he is expected to signal within weeks a prolonged period of low interest rates.

Carney, formerly head of the Bank of Canada, has been asked by finance minister George Osborne to report in early August on the merits of announcing milestones the UK economy that would signal monetary policy could be changed - effectively forward guidance on interest rates.

With Britain's economy recovering at a record slow pace and expected to lag U.S. growth, this could see sterling weaken further against the dollar.

The pound has lost more than 5 percent against the dollar and euro this year.

Investors in the options market have been betting on a weaker pound for much of the year but with Carney's arrival imminent, they have been emboldened to place even larger bets that it will drop to $1.50 by mid-July from around $1.5250 currently. Some banks expect a fall to $1.43 by year end.

Having the BoE give an outlook for monetary policy would bring it into line with the U.S. Federal Reserve, which this month outlined a possible timetable for slowing its bond-buying stimulus programme. Carney introduced forward guidance at the BoC in 2009.

"Carney will pursue forward guidance, which is a method of telling markets that rates will remain low for long," said Alvin Tan, currency strategist at Societe Generale. "We are expecting the pound to drop to $1.43 by year-end as the U.S. economy is expected to do much better."

Reflecting that, the yield gap between 10-year U.S. Treasuries and British gilts is near its widest in seven years in favour of Treasuries.

The Fed's signal led to a sell-off in bond markets with UK short-term rates edging up in sync. The British economy grew 0.3 percent in the first in the first quarter after two years of stagnation but data showed on Thursday that output is still 3.9 percent below its pre-recession peak.

As such, the UK can ill afford higher interest rates and a minority of Monetary Policy Committee members favour more BoE bond buying.

"The risk that the BoE chooses a more active form of forward guidance to keep policy loose is not priced into cable at current levels," said UBS chief currency strategist Mansoor Mohiuddin. UBS sees the pound at $1.47 in three months.

CRUCIAL WEEKS

A Reuters poll published on Wednesday showed economists expect no changes to monetary policy at Carney's first MPC meeting next week. The poll gave a median 40 percent chance the BoE would top up the 375 billion pounds it has so far pumped into the economy before the end of this year.

That median has been steadily falling in recent polls as UK economic data showed that the worst was probably past.

Nevertheless, the minutes of the meeting, to be published on July 17, will be closely watched for clues to whether Carney voted for more asset purchases. This explains why some hedge funds are betting on a weaker pound around that time.

"Investors would be quick to focus on the MPC minutes looking for indications of further easing ahead. Against this background sterling short would remain attractive," said Valentin Marinov, currency strategist at Citi.

Carney is expected to detail the "forward guidance" plan with the Quarterly Inflation Report on Aug. 7.

"There are huge expectations that Carney can deliver on the next wave of growth," said Howard Jones, partner at RMG Wealth Managers. "We are not sure what he can do to lift growth. We remain short sterling/long dollar for a drop to mid-$1.40s."



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