Sterling fell sharply against a resurgent Japanese yen on Wednesday as warnings against one-way bets in currency markets tempered investors' appetite for risk, causing them to cut exposure to carry trades.
Japan's Finance Minister Koji Omi said on Tuesday it was important to be aware of the risks of making one-way currency bets. Foreign exchange officials from South Korea and New Zealand also said they were worried about the harm caused by the yen's weakness, compounding concerns about carry trades. The trimming of long sterling/yen positions - created by borrowing in the low-yielding currency to fund purchases of the pound for its 5.5 percent yield - fed into sterling/dollar, which pulled back from the $2 mark.
Sterling/dollar losses were limited however, while the pound also held steady versus the euro on expectations that the Bank of England could raise rates as early as next week.
"The main theme out there is people trimming carry trades generally on the back of risk aversion - if you look at the VIX index of stock market volatility, that has shot up, showing markets becoming averse again," HBOS currency strategist Naeem Wahid said. By 1424 GMT, the pound was down 0.7 percent on the day at 244.38 yen. It was down 0.1 percent at $1.9970, while the euro was flat at 67.29 pence.
AIB Group Treasury economist Geraldine Concagh said that although sterling had backed away from the $2 mark reached this week, a bullish tone was still intact due to expectations for UK interest rates to rise soon.
Rate expectations shifted last week after minutes from the Bank of England's last rate-setting meeting showed 4 of its nine-strong monetary policy committee voted to raise borrowing costs from the current 5.5 percent. Most economists polled by Reuters after the minutes expect the BoE will hike interest rates to 5.75 percent in July and markets are pricing in further rises after that.