Rate cut may buck the trend and help sterling

Today, as Sterling hits an all time low against the Euro, the Bank of England has announced a 0.25% cut in interest rates to 5%.

While this might normally signal trouble as investors seek out new markets, given the unprecedented nature of the markets at the moment, currency specialists HiFX suggest that this move could in fact give Sterling the chance to recover some of its lost ground.

Marc Cogliatti, Currency Strategist at HiFX explains: "In recent years, currencies and their respective interest rates have followed close correlation. For example, when interest rates have gone up in a particular country, the currency has appreciated as it becomes more attractive for investors hunting yield. However, when interest rates come down, or even when they are expected to come down, the currency begins to suffer as investors turn their attention elsewhere. In the exceptional circumstances we find ourselves in at present, this rule may not necessarily apply. Instead, by cutting interest rates it may be seen as a positive for Sterling, given that it should help minimise any downturn in the UK economy. The other point to consider is that Sterling is now at an all time low against the Euro. While there are still risks to consider, now that today's rate cut is out of the way, it may give Sterling the chance to recover some of its lost ground."

In recent months Sterling has continued to be the worst performer out of all the major currencies. Against the Euro, the Pound has fallen over 8% since the start of the calendar year and almost 17% since July 2007. Whilst this is partly down to the strength of the single currency, it's a recurring theme in the other Sterling crosses (falling over 23% since July '07 against the Japanese Yen and almost 18% against the Australian Dollar).

However a rally for Sterling does depend on today's rate cut helping the British economy. The Federal Reserve have cut US interest rates by 3.0% since their peak last summer in an aggressive bid to shore up the ailing US economy yet, in comparison the Bank of England have still only managed a 0.75% cut.

Cogliatti continues: "Many will question whether the Bank of England could, or should, still do more, as the Fed have done, in terms of rate cuts. However, the two economies either side of the pond are very different in nature and what is right for one, is not necessarily right for the other. The main difference is the problem of inflation and the way the two central banks are tasked with controlling it. The Bank of England's remit is to control inflation and maintain price stability. With CPI running well above target at 2.5% y/y, the MPC have limited scope to cut interest rates. However, the Federal Reserve place less emphasis on inflation and instead look at growth prospects as well and therefore have more scope for monetary easing."

Today's decision by the Bank of England to cut interest rates by ¼ point will come as little surprise to the market. It follows a number of disappointing data releases in recent weeks, particularly from the UK housing market. The clincher was probably the release of the Halifax house price survey this week which showed prices falling 2.5% in the month in March, the steepest monthly fall since 1992, taking the annual rate of growth down to just 1.1%. Whilst a correction in the housing market is seen to be a good thing by many commentators, it will cause concern to others given that it has been one of the pillars for economic growth over the past ten years.

For more information, visit hifx.co.uk.