07:32 AM EDT, 07/29/2024 (MT Newswires) -- Sterling (GBP) has given back some of its recent gains over the past week as it has been caught up in the broad-based positioning unwind, said MUFG.

It has resulted in cable falling back towards support from the 200-day moving average at around 1.2850 after failing to sustain a break above the 1.3000 level earlier this month, wrote the bank in a note to clients. The release of the latest IMM report revealed that Leveraged Funds had continued to sharply build up long sterling positions prior to last week.

Long sterling positions increased sharply for the second consecutive week and totalled 83,168 contracts in the week ending last Tuesday. It was the longest sterling position since the end of July 2014 which leaves it more vulnerable to a position squeeze in the near term, stated MUFG.

Those long sterling positions have been encouraged by the improving fundamentals of the United Kingdom economy, pointed out the bank. The UK economy's cyclical momentum has been much stronger than expected in the H1 of this year, and the large majority for the Labour government should provide greater political stability which should be more supportive to the growth outlook.

The new government is expected to announce the results on Monday of the public spending audit. It has been reported in recent days that the audit will indicate that there is an additional spending gap of 20 billion pounds that the government has to fill. It will set the stage for the government to announce tax hikes in the fall budget as the government seeks to put in place unfavorable policy steps at the start of its term in power, noted MUFG.

The government has pledged not to raise income tax, national insurance or VAT (sales tax) which limits its room for maneuver.

The higher yields on offer in the UK than in most other G10 economies remain attractive for the sterling. MUFG is sticking to its call for the Bank of England (BoE) to begin lowering rates on Thursday but acknowledges that it is a close call.

MUFG's call for a 25bps cut mainly rests on the guidance from the June meeting in which it was revealed that some Monetary Policy Committee (MPC) members' decision to leave rates on hold was "finely balanced." It would only take three MPC members to change their mind and vote for a rate cut this week, added MUFG. The most likely candidates to change their minds are Governor Andrew Bailey, Deputy Governor Sarah Breed and Chief Economist Huw Pill.

New Deputy Governor Clare Lombardelli will also be voting for the first time. However, in a recent speech Chief Economist Pill indicated that he was unlikely to vote for a cut as soon as this week. The UK rate market is currently pricing in around 14bps of cuts for this week, according to the bank.

MUFG judges that the balance of risks is skewed to the upside for the sterling. If the BoE disappoints and leaves rates on hold then the GBP will strengthen further. On the other hand, if the BoE cuts rates, the GBP will initially weaken but could quickly rebound once the dust settles supported by cautious guidance from the BoE over further easing.

The bank expects the BoE to deliver similar guidance to the European Central Bank (ECB) by indicating policy isn't on a pre-determined path and it will continue to monitor inflation persistence risks. The upshot is that rates in the UK are still likely to remain higher than in most other G10 economies, added MUFG.