Sterling dragged down by large UK twin deficits

21/12/2013 10:55 AST

Sterling fell for a second straight day against the dollar on Friday, hurt by a bigger-than-expected current account deficit and larger government borrowings, with rising US yields also helping the greenback.

Official data showed Britain's deficit with the rest of the world widened to 20.7 billion pounds from 6.2 billion in last second quarter, equivalent to 5.1 percent of GDP — its biggest share since the third quarter of 1989, and much higher than the 13.85 billion forecast.

The biggest current account deficit in decades may worry Bank of England policymakers who earlier this week flagged concerns about the adverse impact of a higher exchange rate on the recovery and efforts to make the economy more export-orientated and less dependent on credit-fueled domestic demand.

Data also showed that public finances suffered in November with public sector net borrowing at 16.505 billion pounds, up from 15.586 billion pounds a year earlier.

The twin deficits dragged the pound lower against the dollar and offset any impact from a higher year-on-year reading of final third-quarter gross domestic product. Sterling fell 0.25 percent to $1.6332, compared with $1.6360 before the UK data was released.

"The blow out in the current account deficit isn't great news and we get the feeling that most of the good news is already priced into sterling," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

"A move toward $1.6450 certainly appears to be a sell unless we get more data that shows that demand is holding up well in the economy."

Part of the pound's weakness was also because the dollar extended gains after the Fed voted to reduce its monthly asset purchases by $10 billion. After a subdued initial reaction, the reduction in Fed stimulus has lifted US bond yields and buoyed the greenback.

The euro also gained around 0.1 percent against sterling, rising to 83.55.

Despite its recent losses, the pound is on track to post gains against the dollar this year. Gains have picked up in the last six months as the UK economy improved faster than many of its European peers and investors have priced in the chance of an earlier than previously expected rate hike by the BoE.

The BoE said in its forward guidance in August that it would not consider raising rates until unemployment fell below 7 percent, something it expected to happen by the end of 2016. It was forced to revise that message, stressing rates would not rise any time soon, after admitting unemployment could hit 7 percent as early as the fourth quarter of 2014.

This week data showed the jobless rate at 7.4 percent leading the sterling overnight interbank average rates to price in the chance of a rate hike within 15 months, compared with two years before the numbers were released.

Analysts expect the BoE to quell these expectations by sticking to its pledge to keep rates low for longer. BoE policymakers could step up their rhetoric against the further sterling gains, they said.

"The potential for further sterling upside is a threat to the economic recovery," said Jane Foley, senior currency strategist at Rabobank.

"The (BoE's) Monetary Policy Committee voiced its dissatisfaction in the minutes of the December policy meeting. The bank cannot, however, complain that sterling is overvalued since it remains below its long term trend versus both the dollar and the euro."

Reuters