Dollar weakness hoists pound, but outlook bleak

LONDON: Sterling firmed on Thursday, erasing most of this week's losses, after US Federal Reserve Chairman Jerome Powell weakened the dollar by leaving the door open for rate cuts.

The pound edged higher thanks to broad-based dollar weakness, snapping a recent losing streak, but a weakening economy and Brexit fears kept a firm lid on gains.

The British currency had briefly plumbed a two-year low this week at $1.2439 -- excluding a "flash crash" episode on Jan. 3 when it dropped to as low as $1.2409. On Thursday, it gained 0.3% to $1.2549 after peaking at $1.2571.

Versus the euro, the pound also edged up 0.3% to 89.69 pence, but was still on track for a record 10th consecutive week of losses.

Though Powell's dovish tone in congressional testimony on Wednesday helped the British currency recover somewhat, it has fallen 3.7% in the last three months, the losses accelerating as Bank of England Governor Mark Carney this month appeared to signal the possibility of a rate cut.

"With downside risks to the UK economy growing and Brexit tensions set to escalate again in the autumn, our view is, therefore, that the (Bank of England) MPC is unlikely to be in a position to follow through on its 'gradual and limited' (tightening) rate guidance," said Peter Schaffrik, global macro strategist at RBC.

Dismal data, rate cut possibilities and the risk of Britain crashing out of the EU without transitional trade arrangements have prompted hedge funds to ramp up short bets against the currency to their highest level since October 2018.

Virgin boss Sir Richard Branson told the BBC that if Britain were to leave the European Union with no deal, the pound would plummet to parity with the dollar.

RBC's Schaffrik said his bank expects a 25 basis point BoE interest rate cut in November, whereas previously it had forecast a cut in the first quarter of 2020. Money markets are pricing in a 33% chance of a rate cut in November.

Brexit is still "the major influence on both the outlook for the UK economy and, by extension, the path of the bank rate", he added.