Scenarios and Things to Come during 2006

Sterling on course for worst year vs dollar since 1992
Fri Dec 30, 2005 1:19 PM GMT



By Katie Hunt

LONDON (Reuters) - Sterling held steady against the dollar in thin holiday trading on Friday, but remained on track for its biggest annual drop against the U.S. currency since 1992.

Sterling showed little reaction to news on Friday that house prices rose by 0.5 percent this month, bringing the total gain in 2005 to 3 percent -- the weakest full-year increase in 10 years, according to Nationwide building society.

That is a sharp slowdown from the 12.7 percent annual gain seen in 2004 but nevertheless added to signs that the country's residential property market is stabilising, as the latest yearly rate exceeded the 2.4 percent seen in November.

"If you look at the data in terms of the interest rate debate it's not as important as half a year ago because there are enough indications now that the housing market has stabilised. Now the issue is whether the rest of the economy will pick up, particularly private spending," said Petya Koeva, FX strategist at Barclays.

By 11:35 a.m. sterling was down 0.1 percent against the dollar at $1.7217 . The currency has fallen 10 percent in 2005 -- its steepest annual loss against the dollar since 1992.

The pound lost 19 percent that year, when Britain abruptly left the European Exchange Rate Mechanism, a precursor to the euro, amid big speculative bets against sterling.

Sterling lost ground in 2005 as rising U.S. interest rates have eaten away at the pound's rate advantage over the dollar.

The cost of borrowing in the UK was cut from 4.75 percent to 4.5 percent in 2005 to shore up flagging economic growth. U.S. interest rates have risen from 2.25 percent to 4.25 percent, powering a dollar rally.

"Cable (sterling/dollar) could go lower in the first half of the year as we think the Fed will continue to hike rates, but in the second half we might see a recovery in sterling," said Jeremy Stretch, currency strategist at Rabobank said.

The pound has been under pressure in recent days after minutes of the Bank of England's December monetary policy meeting released last week fanned talk of an interest rate cut in the New Year.

Investors will look to the latest surveys of the manufacturing and services sectors next week for clues on the future path of interest rates.

Against the euro, the pound was down 0.1 percent at 68.72 pence on Friday . The euro has fallen almost three percent against the pound in 2005.

Trade was thin on Friday, with gilt and short sterling futures closing early on the Euronext Liffe exchange.

Major foreign exchange trading centres of London, Tokyo and New York are closed for public holidays on Monday.

Over the next 12 months, sterling is expected to firm against the dollar but weaken against the euro as interest rate differentials shift, according to a Reuters poll in December.

Median forecasts see sterling strengthening to $1.78 in a year's time, based largely on expectations that the dollar's uptrend will fade once the U.S. Federal Reserve ends its current rate rise cycle.

The pound is forecast to ease to 69.99 pence per euro, reflecting uncertainty about the direction of British official rates in contrast with a conviction that euro zone rates will rise gradually in 2006.