Pound's outlook seen brightening as way clear for BOE rate boost

[LONDON] The pound may arrest its slide against the euro because the Bank of England will increase interest rates much sooner than markets are predicting, according to BNP Paribas SA.

Sterling has weakened one per cent against Europe's single currency this month, extending the 3.8 per cent drop in August that was its biggest slump in 2 1/2 years.

That's set to change now Federal Reserve chair Janet Yellen has confirmed the US is still on course to raise interest rates this year, said BNP Paribas analysts including global head of foreign-exchange strategy Steven Saywell. Ms Yellen's comments on Thursday reinvigorated speculation the BOE will follow suit with tighter policy and that the European Central Bank may expand quantitative easing.

"Market pricing for the Bank of England looks excessively dovish," the analysts wrote in a Sept 25 note to clients. "We expect the ECB to respond to a stronger euro with more easing, and see scope for euro-sterling to move lower." Forward contracts based on the sterling overnight index average, or Sonia, still suggest that a full quarter-point increase to the UK's 0.5 per cent official rate won't come until November 2016.

That's later than the early-2016 increase BOE Governor Mark Carney signaled at the central bank's September meeting. And BNP Paribas predicts officials will act even sooner, by February.

The pound weakened 0.2 per cent on Friday to 73.78 pence (S$1.60) per euro as of 5:22 pm London time. It dropped 1.1 percent in the month to $1.5178.

The BNP Paribas strategists said they're shorting euro- sterling, which means betting on the shared currency weakening versus its UK counterpart. They entered the trade at 73.95 pence per euro and are targeting 70 pence.

Next week may show an improvement in UK economic data which would encourage the BOE to move sooner, the analysts wrote.

A gauge of manufacturing will show the sector expanded for a 30th straight month in September, albeit at a slower pace than in August, according to economist estimates before the Oct 1 report.

BLOOMBERG