By Gary Howes

The fortunes of the Pound Sterling to Aus dollar exchange rate has taken a dramatic turn today with the AUD surging higher against a wounded UK currency.

At 14:40 in London the pound sterling to Australian dollar exchange rate (GBP/AUD) has collapsed by 1.5 pct to reach 1.8044.

The decline in the GBP/AUD rate comes amidst broad-based GBP weakness; the UK currency has collapsed in a classic short-squeeze move that has kicked a large number of those holding sterling out of the market.

(Please note our AUD quotes are taken from the spot markets; your bank will subtract a discretionary spread when passing on their retail rate. However, an independent FX provider will guarantee to undercut your bank's offer and deliver you up to 5% more currency. Please learn more here.)

Uncertainty ahead for the British pound

Markets are selling the pound sterling on the assumption that the Bank of England has been let off the hook - the BoE won't have to tighten policy in light of the recent slow down in economic performance is the current thinking. It was this assumption of early tightening that was fuelling the current rally.

Christopher Vecchio at FXCM says upcoming inflation data will be critical for sterling in light of this view:

"The BoE is worried that higher rates resulting from a stronger economy will be self-defeating; right or wrong, it is attempting to front-run an accelerated tightening cycle.

"Accordingly, because the BoE needs a soft price environment in order to justify a dovish shift in policy – the desire to keep rates low so as to not choke off growh - we are watching this Tuesday’s December UK Consumer Price Index release with great anticipation.

"Confirmation that inflation remains pinned below the BoE’s +2.5% (y/y) forward guidance circuit may be the signal for a dovish shift at the February meeting – and that may be setting up the GBPAUD and GBPJPY for technical corrections in the coming days."

Aus dollar strength returning

Meanwhile, the Australian dollar (AUD) is seeing sentiment improve dramatically.

"The disappointing US NFP report offered an excuse for the AUD to rally closer to 0.90. Yet, with a very determined RBA to keep the AUD lower and softer data out of China, we would chose to fade any rally above 0.90. With the OIS curve having gone from downward sloping to being virtually flat the scope for disappointment is significant," says a currency market note from UniCredit Bank.

Boris Schlossberg at BK Asset Manager reckons the AUD/USD rate is due to climb further:

"The Aussie meanwhile appears to be benefiting from a bout of short covering both against the greenback and on the crosses.

"Friday's weak US data provided the initial excuse for the move, but today's price action suggests that the move could extend. The pair has rebounded to 9045 in London dealing and if it can clear the 9050 barrier it could triggers a squeeze all the way to 9100 as the day proceeds."

So for those holding out for better GBP/AUD rates it could be a while till we see recent highs.

At the same time we do see the British pound outperforming the Aus dollar in 2014; a resumption of the rally will inevitably return.