British pound takes pounding

February 20, 2013: 12:23 PM ET
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NEW YORK (CNNMoney)

The British pound is under pressure as investors anticipate new stimulus measures from the Bank of England.

The pound is down nearly 6% versus the U.S. dollar so far this year. On Wednesday, the pound fell to its lowest level since June 2012.

The sell-off is being driven by speculation that the Bank of England will reactivate its quantitative easing policy, as the U.K. economy struggles to avoid falling back into recession for a third time since 2008.

The central bank allowed its £375 billion bond buying program to expire in November. But meeting minutes released Wednesday showed that the three members of the monetary policy committee, including Gov. Mervyn King, voted in February for further stimulus worth £25 billion.

Mark Carney, the Canadian central banker who will replace King later this year, has also indicated a willingness to expand the bank's balance sheet, said Ashraf Laidi, chief global strategist at City Index in London.

"Recent statements by the current and upcoming governors seemed like a battle between who could do the most easing," said Laidi. "This gave traders little choice but to sell sterling."

Related: Bonds are riskier than stocks

The Bank of England would not be the first global central bank to ramp up its stimulus measures this year. The Bank of Japan announced plans last month to make "open-ended" purchases of government bonds in an attempt to reflate the Japanese economy.

These policies are designed to help revive economic growth, but also undermine domestic currencies. The Japanese yen has plunged 13% versus the U.S. dollar during the past three months.

A weaker currency can make a nation's exports more competitive on the global market.

The Federal Reserve has had similar policies in place for years, and the U.S. central bank has said it will continue buying bonds until there is meaningful improvement in the job market.

The move toward more accommodative monetary policies by central banks in advanced economies around the world has raised concern about a global currency war.

The Group of 20 world economic powers pledged over the weekend to refrain from so-called competitive devaluation. But the group's official communique seemed to suggest that undermining domestic currencies through easy monetary policies is acceptable as long as the goal is to stimulate domestic growth.

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The latest G20 proclamation "is a bit of a joke," said James Rickards, senior managing director at Tangent Capital Partners and author of Currency Wars: The Making of the Next Global Crisis.

Related: G20 pledge: No currency war

"The Bank of England will continue to ease monetary conditions and will make an effort to lower the exchange value of the pound," said Rickards. "One should expect that the pound will be heading the same way as yen," he added.

The pound may continue to weaken but it's unlikely to depreciate as much as the yen, said Ken Dickson, director of currencies at Standard Life Investments in Edinburgh.

The yen had been "overvalued for years" and the recent depreciation has brought the Japanese currency more in line with fair value, said Dickson. By contrast, the pound has been trading "on the cheap side of fair value" for the past few years, he added.

In addition, the British economy, although weak, is not suffering the severe deflation that has plagued Japan for the past decade. Exports also make up a much smaller share of the British economy, when compared with Japan, so it's unclear how much a weak currency will help.

"There's already a lot of bad news priced into sterling," said Dickson. "Some of the negative economic sentiment may have been over played."

Meanwhile, investors have been shorting the pound by buying up contracts that allow them to profit from further declines.

The latest Commodity Futures Trading Commission report showed a net short position worth $1.6 billion, analysts at Scotia Capital wrote in a note to clients.

Still, short interest in the pound remains well below the levels seen in May 2010.

"While market participants are bearish, I am not sure they have placed a big [pound] short bet yet," notes Kit Juckes, head of currency strategy at Societe Generale.

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