LONDON: Sterling traded just off a three-week high against the dollar and edged higher against the euro on Wednesday, with some analysts saying 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 no worse than a preliminary reading two weeks ago, helping the pound hold above $1.33, down just a third of a percent on the day against a broadly stronger dollar.
Strategists point to US futures data and other measures that show bets in the market are heavily stretched in favour of more losses for the pound, and a Reuters poll on Wednesday called for sterling to weaken to $1.25 this year.
But the extreme positioning also makes it difficult for players to sell more of the currency immediately 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." That would offer players the chance to take new positions against the pound after any bounce, he noted.
"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.
Foreign investors bought a net 8 billion pounds of UK government bonds in June and almost 4 billion pounds a month earlier, data showed.
Gilt prices were roughly steady on Wednesday, in line with Bunds and little changed by the services data.
Benchmark 10-year yields stood at 0.81 percent, down from around 1.35 percent before the Brexit vote but above a record low of 0.686 percent hit on July 29.
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