QE threatens sterling link with riskier assets

A second round of quantitative easing by the Bank of England could threaten sterling's robust relationship with riskier assets, limiting the gains it has traditionally made when stocks and commodities do well. Instead, the pound could trade more like the safe haven dollar or yen, attracting investors more concerned with protecting their capital than generating high returns.
With the BoE signalling more easing in coming months by printing money and expanding its balance sheet, UK government bond yields are likely to ease. This should see sterling underperform even if stocks or commodities rally. Sterling is traditionally seen as more dependent on economic growth than the dollar and yen and has had a positive correlation with stocks in the past three years. It is often considered to be at the riskier end of the G10 currency spectrum, but that could be set to change.
"QE is a clear negative for sterling," said Derek Halpenny, European head of currency research in Bank of Tokyo-Mitsubishi. "On days when you have a strong risk rally it is clear that the pound is underperforming." Sterling's has underperformed the euro , Australian and New Zealand dollars this week. While they all rallied between 3.2 and 4.2 percent against the greenback, the pound gained only 1.6 percent.
The BoE last week launched a 75 billion pounds asset purchase programme to take place over the next four months. But analysts say it is likely to expand that programme early next year, pushing down longer-term UK yields and flattening the government bond yield curve. "Cable bulls should be very wary here. The BoE could end up squeezing long-term yields sharply lower. This would reduce the carry attractions of sterling," said Mansoor Mohiuddin, head of FX strategy at UBS. "As a result we maintain our new end-year forecast of $1.40 for cable (sterling/dollar)."
Sterling fell to a 14-month low of $1.5270 against the dollar on October 6, a far cry from this year's peak of $1.6747 struck in April when investors were still pricing in chances of a BoE interest rate hike. But those expectations vanished as a recovery in the UK economy proved fragile and the euro zone sovereign debt crisis and risk of instability in the banking sector drove the BoE to opt for more stimulus.
Barclays Capital said sterling has been highly dependant on growth led by exports, meaning it benefited as a global recovery took shape after the 2008 financial crisis in 2008. As shares and commodities sold off in recent weeks due to worries the debt crisis could spiral out of control, so did sterling. Speculators are running bearish bets on sterling against the dollar and Citi says net shorts have reached a new record equivalent to $5.5 billion.