Sterling slips as expectations for BoE housing measures rise

By Anirban Nag

LONDON, June 23 (Reuters) - Sterling pared gains on Monday as speculators trimmed bets in the currency's favour amid caution the Bank of England could soon move to tighten rules for the red-hot housing sector.

Speculation is growing that the BoE's Financial Policy Committee could tighten mortgage lending rules - or macro-prudential norms for banks lending to the housing market. The measures could be announced on Thursday when the BoE releases its financial stability report.

Such steps could take some of the heat off the BoE to raise interest rates in the near term, but with investors still expecting it to be the first major central bank to tighten policy, any dip in the pound is likely to be bought.

According to the interest rate swap market, investors are expecting a first rate hike before the end of this year.

"Tactically we are more cautious, both in view of the outsize spot moves over the last few weeks, but also, because of the uncertainty which surrounds the announcement on financial policy from the BoE's Financial Policy Committee," said Paul Meggyesi, currency analyst at JP Morgan (Other OTC: JPYYL - news) .

The euro was flat at 79.92 pence, recovering from earlier losses suffered after subdued euro zone economic data highlighted the divergent outlooks for monetary policy at the European Central Bank and the BoE.

Against the dollar, the pound eased slightly to $1.7005 , off a session high of $1.7051 which was not far from a 5 1/2-year high of $1.7064 struck last week. The pound has gained nearly 2 percent in the past two weeks with most of the gains coming after Governor Mark Carney surprised investors by saying rates might rise before many were predicting.

On a trade-weighted basket, the pound has gained about 10 percent in the past year, helped by signs of a rapidly improving UK economy. Most of the recovery has been driven by the housing market where prices are up 10 percent in the past 12 months.

That has put the spotlight on the BoE's ability to prevent a housing bubble. BoE monetary policy committee members like Carney, Charlie Bean, Ian McCafferty and David Miles will appear before lawmakers on Tuesday and they could shed more light on when the first rate hike is likely to be.

This should also give more impetus to Britain's government bond market, where 10-year gilt prices tracked German Bunds higher on Monday on the back of weak euro zone data. Thirty-year gilts underperformed, however, in anticipation of the launch of a new 2045 gilt this week.

Ten-year yields dropped 2 basis points on the day to 2.74 percent, while the benchmark 30-year gilt was unchanged at 3.47 percent, cheapening slightly in price versus the 10-year gilt.

"The Bank of England-induced price action hasn't been particularly conducive to cheapening up the long end of the curve ahead of supply," Sam Hill, a fixed income strategist at RBC (MCX: RBCM.ME - news) , one of the bookrunners, wrote to clients.

Tuesdays are favoured days for syndications, and strategists expect the new 2045 issue with a 3.5 percent coupon to have a volume of around 4.25 billion pounds ($7.23 billion).

DIVERGENCE

Speculators have been raising bets in favour of sterling as they look for a trend in the absence of bigger moves by the euro, dollar and yen. Data from a U.S. financial watchdog showed long positions in sterling futures rose to the highest level since late 2007 last week.

Analysts say the pound is likely to make more gains against the euro than the dollar, given the ECB could still resort to quantitative easing later in the year.

French business activity shrank more than expected and the wider euro zone private sector also slowed this month, data showed on Monday, and that will encourage the ECB to keep policy accommodative.

Over the weekend, ECB President Mario Draghi, in an interview, laid out the case for sticking with the bank's programme of stimulus. He also said quantitative easing may be used if inflation expectations deteriorated in the medium term.

"Disinflation is the biggest problem for the ECB at the moment," said Adam Myers, the head of FX strategy at Credit Agricole.

"If the market calls Draghi's bluff at the ECB and they start betting that QE (quantitative easing) is going to happen, then euro/sterling lower will probably be a better trade than sterling/dollar higher." (Additional reporting by David Milliken and Jemima Kelly; Editing by Larry King and Susan Fenton)