LONDON: Sterling traded just off a three-week high against the dollar and edged higher against the euro on Wednesday, with a number of analysts arguing pricing and positioning offer it a chance to rally after Thursday's Bank of England policy decision.
Money markets have fully priced in a quarter point cut in the Bank's main interest rates and many economists expect it to provide other measures to push more credit through an economy already showing signs of slowing after last month's Brexit vote.
Service sector data on Wednesday was at least no worse than a flash reading two weeks ago, helping the pound recover some early losses to trade just 0.1 percent weaker at $1.3331 in morning trade in London.
More generally, strategists point to U.S. futures data and other measures that show bets in the market are heavily stretched in favour of more losses for the pound.
That makes it difficult for players to sell more of the currency and raises the prospect of investors holding such positions being encouraged to buy the pound and square up.
"It may be that we are predicated for a short squeeze after the Bank's decision tomorrow," said Jeremy Stretch, head of currency strategy at CIBC Global Markets in London.
"The market is extremely short of sterling, largely discounting that 25 basis point cut and some credit easing. So unless the bank is particularly bearish on the economy we may see a squeeze."
At the same time, he said, that would offer players the chance to take new positions against the pound after any bounce.
A quarter of the banks polled last month by Reuters after the vote to leave the European Union predicted sterling would fall to $1.22 or lower by the end of the year.
"We expect more weakness," analysts from Goldman Sachs said in a morning note to clients, saying they were comfortable with earlier forecasts that the pound will fall to $1.20 over the next three months before recovering to $1.25 in a year's time.
Buying by investors expecting the Bank to support debt markets in the months ahead has almost halved 10-year UK gilt yields since June 23, weakening the return for sterling but drawing in more foreign capital.
Gilt prices were a fraction higher on Wednesday, in line with Bunds and little changed after the services data.
But the rebound in benchmark 10-year yields, now at 0.80 percent compared to a record low of 0.686 percent on July 29, has been far less pronounced than in German or Japanese yields.
"The more gilts suffer, the less the pound does, for now," Societe Generale strategist Kit Juckes said.
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