Pound gains vs euro as ECB keeps rate cuts on table

Thu Dec 6, 2012 9:38pm IST

* Euro drops vs sterling, negative rates discussed at ECB

* Little reaction to BoE rate hold

* Fitch warns on UK's triple-A rating

By Philip Baillie

LONDON, Dec 6 (Reuters) - Sterling gained against the euro on Thursday after ECB chief Mario Draghi painted a grim picture of the euro zone economy and said policymakers had discussed negative deposit rates, weakening the common currency.

The euro fell to a session low of 80.66 pence after Draghi's comments, its largest daily drop against the pound in six weeks. It could see further losses after the European Central Bank revised down its euro zone growth expectations, with a near-term target seen at its 200-day moving average of around 80.60 pence.

The outlook for UK economy has also darkened but the Bank of England left interest rates at 0.5 percent on Thursday and kept its quantitative easing programme unchanged as expected.

The euro's losses picked up after the ECB's Draghi said the bank had discussed negative deposit rates, or the rate the ECB pays commercial banks to park excess funds, at its meeting but gave little details.

Cutting the deposit rate would make the euro more attractive as the currency for carry trades, where investors sell a low-interest-bearing currency to buy a higher-yielding one such as the Australian dollar.

"Clearly talk of negative interest rates revived the idea that they may go where no central bank has gone before and that had an impact on market sentiment," said Simon Derrick, head of currency research at BNY Mellon.

"It doesn't mean that is what they are going to do but it suggests that there is an active discussion about something which people hadn't previously taken into account."

But Derrick said a downward revision in euro zone growth forecasts was in line with previous revisions, and was not a major surprise to the market.

"It is a pretty lousy day for the euro," he added.

The pound fell 0.1 percent against the dollar to $1.6085, off a one-month high of $1.6131 hit on Tuesday. Investors are worried that a grim euro zone outlook will hurt the pound, given the UK's strong trade links with the euro zone.

Earlier, data showed Britain's trade deficit widened more than expected in October.

TRIPLE-A SAFETY

Analysts said the pound's gains against the dollar could prove temporary after rating agency Fitch said Britain's credibility had been damaged after finance minister George Osborne said he would not meet a key debt reduction target.

"Fitch and Moody's have had (UK) gilts on negative outlook for a while so it is no surprise," said Geoffrey Yu, currency strategist at UBS. "If one of them downgrades the UK's triple-A status that probably not be the end of the world, but if it was two that might see some forced selling."

Fitch has a negative outlook on Britain's AAA rating and has said it will review it again after Osborne's 2013 budget statement early next year.

"The triple-A rating is everything. It is what has supported sterling from selling off over the last few years and if that were to go you would see gilt yields rising and sterling dropping like a stone," said Christian Lawrence, currency strategist at Rabobank.

The pound is also seen as a safe haven while the debt persists in the euro zone, analysts noted.

Citibank told clients in a note it expects the UK to maintain its triple-A status, given Osborne's deficit-busting programme is a credible solution.

"The Coalition government seems on course to deliver fiscal austerity comparable to the measures we see elsewhere in Europe," Citi said in a note. "As a result, sterling should continue to serve as a safe haven proxy for the euro.

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