Foreign Exchange

Sterling watchers wary of 'shaky' UK recovery

Pound coin
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Sterling may be trading near nine-month highs against a basket of other currencies but for some foreign exchange strategists, time is running out for the pound's recent rally if the U.K.'s economic recovery proves not to be as strong as expected.

The main reason for sterling's strength in the second half of 2013 has been a string of surprisingly good strong economic data out of the U.K., according to David Bloom, global head of foreign exchange strategy at HSBC.

The recent good news includes the resurgence of a housing market that has been helped along by government stimulus, he added, but Bloom expects this recovery is built on "shaky foundations".

(Read More: Weak PMI reinforces case for BoE to hold fire)

"Positive (data) surprises are very unlikely in the long term, simply because expectations adjust upwards. Second, and more importantly, it is difficult to see a sustained increase in U.K. consumer spending while real income growth continues to be negative," he said in a research note released on Thursday evening.

By year-end, HSBC expect sterling to fall lower against the dollar to $1.53 from its current level of $1.598.

Bloom's prediction for a period of softer data for the U.K. could already becoming true with disappointing industrial figures on Wednesday casting doubts on the strength of the recovery.

Output fell by 1.1 percent on the month in August, the biggest drop since September 2012, after rising by 0.1 percent in July, according to official data, which was weaker than the 0.4 percent rise estimated by economists.

On Friday, new data from the Office of National Statistics showed that output in Britain's construction sector fell unexpectedly in August. The fall of 0.1 percent between August and July, after a rise of 2.8 percent the previous month was a clear indication of the disconnect between stellar house price rises and subdued construction activity, according to Eimear Daly, head of market analysis at Monex Europe.

"Rising house prices are usually the result of a growing economy however in the UK house price rises appear to be leading the recovery," she told CNBC. "While the economy may continue to grow robustly into (the fourth quarter), growth will fall short of the market's unrealistic expectations and sterling will adjust lower as a result. We are predicting sterling-dollar to trade towards $1.58 in a month's time and $1.56 by year end."

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This week's disappointing data came in sharp contrast to other major indicators for the U.K. economy with official figures for the second quarter revealing that the U.K.'s gross domestic product (GDP) had expanded by 0.7 percent, putting Britain's growth rate on a par with Germany, the so-called powerhouse of Europe.

However, while the rate of growth has impressed analysts, the U.K. economy is still smaller than what it was at the start of the global financial crisis five years ago.

Geoffrey Yu, foreign exchange strategist at UBS is another that believes sterling is set for a fall but told CNBC that the reasons behind a dip would be slightly more nuanced.

"We do see GBP/USD falling to 1.50 on a 12-month horizon but that is more of a function of our dollar view," he said, explaining that the U.S. Federal Reserve will still look to curb its current asset purchasing program - despite the recent delay by Fed members. This should push the dollar stronger across the board.

But taking a longer perspective, Yu echoes Bloom's comments that the U.K. recovery is too unstable to offer support for sterling.

Choose euro or sterling over dollar: Pro

"Growth will slow," he told CNBC. "Even if foreign capital is willing to head into the country and fund the U.K.'s widening current account deficit, (sovereign bond) yields need to be higher or sterling lower.

(Read More: UK housing shares surge on Goldman's conviction)

"The Bank of England will almost certainly choose the latter over the former because of the financial and growth risks that higher yields entail. That would be the point to go short."

Kit Juckes, the head of foreign exchange strategy at Societe Generale is insistent that flickering signs of a U.K. recovery is so well-formed that the Bank of England could look to forge ahead of the Federal Reserve and the European Central Bank (ECB) and raise its main benchmark interest rate.

"From the end of 1986 onwards, the economy was supported by the housing boom. The pound rose sharply against developed markets and the dollar through 1987/88, and the Bank of England ended up hiking rates by 7.5 percent between mid-1988 and the end of 1989," he said in a morning note on Friday.

"The pound is cheap, the MPC (Monetary Policy Committee) may hike sooner and go further than Fed/ECB," he added, suggesting that shorting the euro against the pound is a great trade for the next three years, not just the next three days.

By's Matt Clinch; Follow him on Twitter