The sterling is being dragged down by the falling euro, but also, the Bank of England just said it had eased monetary policy slightly today, which caught the market by surprise.
The Bank of England announced that it would transfer the interest it collects on the gilts it has bought under QE back to Her Majesty's Treasury. The Treasury, in turn, plans on using those funds to retire debt. Therefore, the market will have somewhat few gilts and more cash. Q.E.D.
This might explain why the BOE did not extend the asset purchase program when it met earlier this week.
In essence, recycling of the coupon back to Treasury, which will pay down its debt (by retiring gilts) is similar, BOE Governor Mervyn King argues, to the BOE buying the gilts -- and removing them from the market.
Recall that there has been talk about the possibility that central banks could "forgive" their own government debt that they purchased under QE-like operations. In the UK, where the speculation appeared to run the highest, officials denied the rumors. The recycling of interest payments on the debt back to Treasury takes on a bit of the appearance.
However, note that central banks, including the Fed and ECB and BBK, do typically turn over their profits, or some part thereof, back to their respective Treasury departments. In some ways, then, the BOE's move is not really that unusual. It does raise questions about the inter-relationship between central banks and governments, which seem more complicated than the mantra about central bank independence
Some will ask: Could the Federal Reserve do the same thing as the Bank of England? The answer is that in some respects it is already doing this when it transfers its profits. The one difference is the the BOE says that its Treasury will reduce the outstanding stock of gilts. When the Fed transfers profits to the Treasury it reduces the borrowing requirement of the Federal government. It does not reduce the current stock of Treasury debt, but it could... .
The sterling initially ticked lower against the euro, on the news, even though the euro was falling against the dollar. However, it quickly was overwhelmed by the selling pressure on the single currency and the sterling recouped what was lost against the euro. It is, though, approaching important support against the dollar near the Oct 23 low of ~$1.5915. A break suggests $1.58 in the coming sessions.
See more from Marc Chandler at his blog Marc to Market.
No positions in stocks mentioned.