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Could sterling fall another 20% as current account deficit widens?

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16/10/2014
Sterling could fall much further against the US dollar if the UK's current account deficit is not addressed, bond managers have said.

The latest data from the Office for National Statistics shows the UK’s current account deficit widened once again in the three months to September and now stands at £23.1bn in Q2, beating the previous high of £22.8bn seen in 2013.

Sterling made a strong start against both the US dollar and euro this year, until fears over a ‘yes’ vote in the Scottish referendum marked a near-term top at just over $1.70.

Sterling has fallen sharply since then and is now down 4 per cent against the dollar year to date at just over $1.59, with a widening deficit adding to downwards pressures.

Ben Lord, bond manager at M&G, said: “Our view is that sterling strength is not sustainable with such a large current account deficit.

“Every time there has been such a deficit, we have a seen a correction in sterling of up to 20 per cent, so we should see [a similar correction] this time.”

Kevin Doran, chief investment officer at Brown Shipley, labelled sterling fundamentally weak, despite recent strength.

“Sterling is fundamentally a weak currency,” he said. “The UK cannot persist with its currency account deficit and expect the currency to remain strong in the long term.

“If the deficit remains as it is, we will have to attract in the realm of £100bn in foreign direct investment. Without this, sterling could drop as much as 15 per cent.”

In the near term, however, Doran sees the strength of sterling as being determined by interest rate expectations.

This week’s surprise drop in UK inflation to 1.2 per cent has reduced the likelihood of an interest rate hike before the general election in May 2015.

When rates do rise, the pound could appreciate as investors see sterling assets as a better option. In that context, some suggest sterling has fallen far enough already.

Gero Jung, chief economist at Mirabaud Asset Management, said: “We do not see sterling depreciating further from here.

“The UK economy is doing well, the unemployment rate is falling, five-year inflation expectations remain above 3 per cent, and even the low CPI reading could be seen positively for consumer spending given weak average weekly earnings.”

However, Jupiter’s Ariel Bezalel said current market pressures will mean talk of a rate rise is soon put on the backburner.

“Sterling looks very vulnerable here. Markets are talking about rate rises on the near-term horizon, but those will be quietly abandoned soon,” he said.

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