Pound to Drop to Euro Parity, Dollar to Reach 85 Yen, BNP Says

By Candice Zachariahs

Sept. 17 (Bloomberg) -- The euro will surge to parity versus the pound and reach its highest level in more than a year against the greenback as investors borrow low-cost funds in the U.K. and U.S. to buy higher-yielding assets, BNP Paribas SA said.

The Bank of England and Federal Reserve are flooding their financial systems with cash to keep borrowing costs low on expectations their economies will recover slowly from recession. That will spur investors to use funds from the nations to buy securities in countries with higher interest rates, BNP Paribas said. The bank raised its forecast for the yen and expects it to climb to its highest since 1995 against the dollar by year-end.

“Sterling is likely to be the weakest currency in town followed by the U.S. dollar,” analysts led by Hans-Guenter Redeker, London-based global head of currency strategy at BNP Paribas, wrote in a note to clients yesterday. “The U.S. dollar has been used as a funding and a reserve currency simultaneously, suggesting the U.S. dollar will depreciate less than sterling.”

The euro bought 89.317 pence as of 10:49 a.m. in Tokyo, from 89.244 pence yesterday in New York. The 16-nation currency rose above 98 pence for the first time on Dec. 30. It advanced a third day to $1.4716 and yesterday reached $1.4737, the strongest level since Sept. 25, 2008.

The yen was at 91.12 per dollar and yesterday hit 90.13, the strongest level since Feb. 12. The pound was at $1.6477 from $1.6493.

The U.S. dollar will slide to 85 yen by year-end and recover to 90 yen in the first quarter, BNP Paribas said, revising forecasts for 93 and 95 yen respectively.

‘Funding Currency’

Benchmark interest rates are 0.5 percent in the U.K. and as low as zero in the U.S., compared with 3 percent in Australia, 7 percent in South Africa and 8.75 percent in Brazil. The yield gap lures investors to borrow low-cost funds and invest in higher-yielding assets in so-called carry trades.

Sterling will weaken in the coming months as the government needs to rein in spending and its central bank is likely to retain an expansionary monetary policy, BNP Paribas said.

“Sterling will degenerate from an investment into a funding currency,” said the analysts.

Moody’s Investors Service warned the U.K. and U.S. will need to “severely adjust their fiscal policies,” in a Sept. 9 report. Both nations have “lost altitude” in their ratings even as they remain resilient, Moody’s said.

Standard & Poor’s in May lowered its outlook on the U.K. to “negative” from “stable” and said it faces a one-in-three chance of a ratings cut as debt approaches 100 percent of gross domestic product.

Fragile Recovery

The pound traded near its lowest since May as a report yesterday showed the jobless rate in the U.K. rose to the highest since 1995. BOE Governor Mervyn King said Sept. 15 policy makers may cut the rate paid to hold reserves at the central bank.

“The strength and sustainability of the recovery is highly uncertain and the balance of risks to inflation around the 2 percent target remains on the downside,” King said.

The euro will trade at 98 pence by year-end and at parity in the first three months of 2010, BNP Paribas said, revising an earlier call for the currency to trade at 88 and 86 pence, according to Bloomberg News data. Sterling will buy $1.57 at the end of the fourth quarter and $1.48 in the following quarter, compared with earlier forecasts of $1.53 and $1.51.

Europe’s single currency will rise to $1.54, the most since August 2008, by year-end and buy $1.48 in the first quarter of 2010, compared to earlier expectations for $1.35 and $1.30.

To contact the reporter on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net