----by NINA KOEPPEN----
LONDON (AFX) - Sterling is expected to rebound in the short to medium term, pushing as high as 1.60 versus the U.S. dollar, despite looming prospects of a rapid monetary easing in the UK, economists said.
Economists almost unanimously agree that the Bank of England will cut interest rates by 25 basis points tomorrow, ringing in a series of forthcoming rate reductions. However, they brush aside conventional text book theory, suggesting that monetary easing will undermine the domestic currency.
"Traditional interest rate arguments will not come into play here; the argument that monetary easing in the UK will help to ensure steady growth should help to support sterling," Will Rugg at Standard & Poor's MMS said.
"I expect cable (stg/usd) to move back above the 1.50 level over the next three months; although the upside will remain limited at 1.55, there is still some scope for further dollar weakness over the next three to six months," Rugg added.
Central bank watchers believe that a more favourable economic outlook in the UK compared to the U.S. will help to keep sterling underpinned, opening the horizon for 1.55-1.60 usd levels.
"I do not think interest differentials are the key driver of currencies at the moment. Much more important are growth prospects. UK growth prospects look much healthier than the U.S. and if anything, a rate cut could even add to the more positive UK growth sentiment," James Shugg at Westpac Banking Corp said.
"We expect cable to be at around 1.51 at the end of March, and at around 1.56 in six months time," he added.
Michael Lewis at Deutsche Bank is equally bullish on sterling although he places different emphasis on the reasons.
"I am relatively positive on cable, as interest rate spreads in the U.S. are pointing towards an aggressive monetary easing by the Fed. ....Levels of around 1.55 to 1.60 (stg/usd) are certainly possible by the middle of the year," Lewis said.
He further noted that even a surprise cut by 0.50 points by the Bank of England tomorrow will not undermine sentiment. "There is still some risk that MPC will cut rates by 50 basis points tomorrow. Still, that will not be too much of a problem for cable, as it could be seen as beneficial for UK growth," Lewis said.
Although the overall short to medium term outlook for sterling remains rosy, some economists warn that an unexpected recovery in the U.S., as well as softer domestic data limit a rally in sterling.
"The biggest risk for cable is that we will get surprisingly strong data out of the U.S., rekindling hopes of a V-shaped recovery in the U.S. We might see cable pushing lower along with eur/usd and other European currencies on the back of that," Rugg said.
"However, I personally expect cable to remain well underpinned," he added.
Factors within the domestic economy, namely a weak labour market report and a soft inflation reading will increase the potential for rate cuts, and in turn undermine sterling, Michael Klawitter at Westdeutsche Landesbank said.
"In addition, cable has also come a bit under pressure from mergers & acquisitions rumours - that BT is buying Telefonica Miviles and that Vodaphone is buying Verizone Wireless," Klawitter added.
"Hence, there are clear risks to the downside for our forecasts for cable, which are for 1.52 in the next three months and 1.48 in six months," Klawitter noted.
At 12:25 pm, sterling was at 1.4618 usd.