Hedge funds are dumping sterling over interest rates

Hedge funds are dumping sterling over interest rates

ORLANDO, Fla. Nov 22, Reuters - One clear pattern has emerged: Hedge funds are dumping sterling because of the confusion over the Bank of England's guidance on when it will start raising interest rates.

Since June last year, the funds are the most bearish on the pound, according to the latest positioning data from Chicago futures markets, marking a historic U-turn since the BoE's surprise decision earlier this month to keep rates on hold.

The data from the Commodity Futures Trading Commission shows that hedge funds and speculators increased their net short position to 31,599 contracts in the week to November 16 from 12,093 the week before.

That is essentially a $2.65 billion bet on the pound falling. The last two weeks, funds were net long more than 15,000 contracts, a total of $1.3 billion bet on the currency.

Only twice since the sterling futures contract was launched in 1988 have there been bigger two week selloffs, in March and December of 2007.

The Bank's rate-setting committee's 7 -- 2 vote on Nov. 4 to keep interest rates at a record low 0.10% was the catalyst this time, despite strong hints from Governor Andrew Bailey and Chief Economist Huw Pill that an inflation-fighting hike was a real possibility.

More confusingly for traders who had followed this guidance and went long sterling, Bailey and Pill were not the two dissenters who called for a rate increase. Both of them went on a mini public relations offensive to clear up the mess.

On Friday, Pill said that the weight of evidence was shifting towards a rise in rates next month, but he had not made a decision. Bailey told The Sunday Times that risks to inflation are two-sided, although he worries that it might be elevated for longer Upbeat UK labor market data last week and helped lift the pound from a one-year low of $1.3350 back above a key chart area around $1.34.

There is a chance that the pound could be at a turning point.

The funds are heavily short, according to the data from the CFTC. The pound bounce back last week is not taken into account in this positioning, which is only up to Nov. 16, and probably doesn't take into account that. There is a full calendar month left until the BoE's next policy meeting, so there is plenty of time for funds to build back longer.

There are signs of labor market strength that are emerging, and the annual inflation is above target at 4.2% and may be close to 5% next year. Rates market pricing is firmly pointing out the second rate hike in almost half a century in December.

The 100 basis points of tightening are fully priced in over the next year. That is pretty aggressive, and is roughly double the Fed's expected tighter path over the same period.

Will the Bank of England tighten its policy? Analysts at Rabobank are cautious about how far rates can be raised without adversely affect the economic recovery, despite fears that the Bank may be making a policy mistake.

A December rate hike is only likely to lead to sustainable gains for the pound if it is backed by stronger UK data releases, they wrote in a note last week.