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Sterling spikes lower on comments from Mervyn King…

The Bank of England is considering a reduction in the deposit rate to discourage banks from hoarding reserves. The Bank of England is of the opinion that such a move could help spread the benefits of quantitative easing to the broader economy. However, Mr King has noted that a similar move by Sweden’s Central Bank the Riksbank has only made a minimal impact.

Mr King stated that there were signs that the UK economy started to grow this quarter but the strength of the recovery is highly uncertain. He noted that the £175B policy of purchasing bonds known as quantitative easing was beginning to impact nominal spending and money supply but there is still a long way to go to get output back to previous levels, whilst risks to inflation remain on the downside.

Such comments make Sterling less attractive as global investors seek higher yields.

As mentioned previously, the future outlook for Sterling remains highly uncertain. The Pound should recover as the UK economy recovers from recession but the timing and strength of such a recovery is still unclear. With Germany, France and Japan already out of recession, confirmation that the UK economy is expanding again is vital to a recovery in Sterling. The market will also need to have some confidence that the UK will not slip back into recession, particularly as the government stimulus ends.

If Sterling interest rate differentials remain negative or even widen further then there is a risk that Sterling will remain weak for some time.