2010/08/06

Sterling ends week's rally on fears that budget cuts could dent economic recovery

Sterling finally ended this week's rally against the US dollar, as investors' optimism about the strength of Britain's economy slightly waned.

The services industry grew at the slowest pace over the past 13 months in July, a sign that economic recovery may not be as strong as expected. The Markit/CIPS services PMI index fell to a lower-than-expected 53.1 in July, down from 54.4 in June, the lowest level since June 2009 and below analysts forecasts.

"The market is expecting strong headwinds in the second half for the UK as the government embarks on its schedule of fiscal reform -this data suggests that the impact may be a little heavier than expected," said Jane Foley, research director at Forex.com.

The pound traded 0.2% lower at $1.592 at 11.30am. The recent rally had been pushed by strong economic data, including second quarter economic growth and better than expected manufacturing indicators. Strong bank results from HSBC and the expected return to profits from Lloyds Banking Group and the Royal Bank of Scotland also added optimism about the health of the economy.

Draconian budgetary cuts pleased bond investors, who care more about inflation and getting their money back than about unemployment figures, lifting demand for UK government bonds and, therefore, the value of the currency.
"The cost of this toughness could be relatively weaker UK growth ahead and that could end this sterling rally against the dollar," said Steven Barrow, head of G10 strategy at Standard Chartered Bank.
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