Sterling hits two-month low as dollar gains

[December 28, 2016]  By Patrick Graham and Jemima Kelly

LONDON (Reuters) - Expectations U.S. inflation and growth will outstrip the rest of the developed world's prodded the dollar higher across the board on Wednesday, knocking half a cent off the euro and driving sterling to a two-month low.

Further gains for the greenback are one of the big consensus plays for financial investors going into 2017, although there have been signs of more doubt in recent weeks, with analysts beginning to wonder how much further appreciation a Donald Trump White House will tolerate.

After a mixed morning in Europe, by 1150 the dollar was up 0.6 percent at $1.0399 per euro and 0.3 percent at 117.78 yen. Sterling also fell as much as half a percent to reach $1.2222, its lowest since Nov. 2, before steadying.

"Our case is that there’s probably a bit more room for (the dollar) to run," said Dominic Bunning, a strategist with HSBC in London.

"And if it does, (the market will look at) how long before the combination of higher rates and a stronger dollar start to weigh on the U.S. economy and tighten financial conditions enough that it slows the economy."

Some analysts pointed to the rise in the European Central Bank's estimates of how much additional capital will be needed to prop up Italian bank Monte dei Paschi di Siena as another source of euro weakness.

With little evidence of much speculative money at work in reduced holiday volumes, Bunning said there was likely to be steady pressure on the pound from Britain's large current account deficit - seen as an important weakness as the government heads into negotiations on its EU exit.

U.S. dollar and British pound notes are seen in this November 7, 2016 picture illustration. Picture taken November 7. REUTERS/Dado Ruvic/Illustration

"In a world where you have a current account deficit that is 5 or 5.5 percent of GDP ... the pressure on the currency will continue to weaken it if there isn’t capital to finance that deficit," he said.

Trump's concern over the rate of the Chinese yuan is well known, but BNY Mellon strategist Simon Derrick also points to similar comments he made earlier this year on Japan's drive to weaken the yen.

"While the market collectively may not be focusing on the story, dollar strength could become a domestic political issue in 2017 should it persist," Derrick said.

"Should the dollar make substantial gains from here, particularly against the yen, it will be interesting to see how president-elect Trump responds given his previous comment."

The dollar has gained 16 percent against the yen from lows hit on U.S. election night in November.

(Editing by Andrew Roche)

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