Sterling at 2.5-year low vs. dollar after rating cut

More falls are likely in the near term given a grim outlook for the British economy, the prospect of more monetary easing and growing evidence that the Bank of England (BOE) is comfortable with a falling currency as it seeks to rebalance the economy and encourage more exports.

Moody's on Friday cut Britain's rating by one notch to Aa1 from Aaa, citing weak prospects for economic growth. Britain joined the United States and France in having lost its triple-A rating from at least one major agency.

So far this year sterling has lost nearly 7 percent against the U.S. dollar while the euro has gained 7.5 percent against the pound. All of which has dragged the currency's trade-weighted index to a 17-month low of 78.5, BoE data showed.

The pound was down 0.1 percent against the U.S. dollar at US$1.5155, having fallen to US$1.5073 earlier in the session, its weakest since mid-July 2010. Traders said any bounce towards US$1.5250-US$1.5300 would be sold into as more speculators and investors take a dim view and build bets against the currency.

The euro was up 0.8 percent at 87.22 pence, not far from a 16-month high of 87.75 pence. Investors who bought UK gilts as a way of seeking safety from the eurozone crisis last year continued to turn around those bets; gilt futures fell more than 50 ticks in early trade.

“(The rating cut) reinforces the perilous economic position the UK is in. It supports the unwinding of the safe haven trade too,” said Kathleen Brooks, research director at Forex.com.

“This downgrade may fuel more speculation that QE will be re-started later this year. This is pound negative for the medium term and we could see sub-US$1.50 in the near term.”

More quantitative easing is seen as a negative for the currency as it involves the central bank printing more money to buy bonds. That increases the supply of the currency and puts more pressure on its value.

Sterling was already under pressure last week after Bank of England minutes showed policymakers, including Governor Mervyn King, edging closer to another round of easing. The bank's quarterly report earlier this month also said policymakers were prepared to tolerate higher inflation to support growth.

“By moving the goal post of its 2-percent inflation target from two to three years, the BOE has reduced real rate expectations, markedly pushing the pound lower,” Morgan Stanley said in a morning note.

“Now rising inflation and pound weakness will pare living standards back down. We expect sterling to fall further and Friday's rating downgrade was a marginal event in dictating the future path of the currency.”

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