Sterling set for a positive start to the New Year

Duncan Higgins, senior analyst at Caxton FX says that, "The pound has mirrored this improvement, gaining 8% from its lowest point in December 2008, when it hovered just above parity with the euro. As we near the end of this year, sterling is trading in a far stronger position with economic figures continuing to show improvement."

Higgins states, "We are expecting sterling to maintain this current upward trajectory as we enter into the New Year, though progress will be slow. The pound is facing strong headwinds from its spiralling fiscal deficit and lingering concerns over quantitative easing." With no confirmation from the Bank of England that stimulus measures have come to an end, the market is hesitant about taking the pound too high.  Higgins continues, "Nonetheless, positive economic signs are building, which gives us an encouraging view over the medium term. This month data has revealed improvement above expected levels in both the manufacturing and services sector, which has market analysts optimistic over the UK's growth prospects for the last quarter of this year. Unemployment too, though still at record levels, does appear to have levelled out some way short of the 3 million figure that some had feared it would reach."

Additionally, the euro is continuing to find resistance in its upward movement against the US dollar at the psychologically important $1.50 level, which is supporting the GBP/EUR price. ECB President Jean-Claude Trichet is continuing to express concern over the strength of the single currency, which is stifling demand. Higgins explains, "The pound has already briefly breached €1.13 this year and we see the price pushing up nearer €1.15 in the early part of 2010."

In relation to the US dollar, the pound has advanced some 13% since this time a year ago, though looking ahead over the coming weeks; the pound is unlikely to consolidate a position above $1.70. Though the greenback is commonly held to the weakest of the major currencies at the moment, the US currency may find support as investors unwind short positions and book profits towards the year end.

Higgins says, "Into 2010, we expect the dollar's downward trend to resume. It is in the process of losing its "safe-haven" appeal as the combination of an extended period of low US interest rates and improving global economic conditions favour higher-yielding currencies. Recently Ben Bernanke has made comments acknowledging the need for a strong dollar. However, there is currently little mention of any concrete policy to achieve such a scenario and investors will continue to sell the US currency as long as the Fed maintains its low interest rate policy. With this is mind, we can expect to see the pound reach above $1.70 as we move through the early stages of 2010."

Though the UK currency may find some traction, the New Year may see conditions remain tight for the British consumer. As of January 1st the national VAT rate is returning to 17.5% in a move to increase government revenue, as the level of public debt threatens to undermine recovery. Some say it might even go up to 19%. For the consumer though, this move will conclude a period of "cheaper" high street prices and could stifle consumer spending.

In addition, the BoE has warned of short term inflationary pressures. Indeed last week, data revealed a 0.2% increase in the national inflation rate in October with rising fuel and food costs at the heart of the rise. The Bank of England is expecting inflation to slow over the long-run, with the rate remaining below the target 2% into 2011. However, in the short term we are set to see prices continue to rise, which may put a strain on economic recovery as consumers are forced to scale back their spending.