Pound at 26-year high against dollar as the hot money pours into sterling

Ashley Seager
London Guardian
Tuesday July 3, 2007

The prospect of a further UK interest rate rise this week and continued problems in the United States housing market combined yesterday to push the pound to its highest level against the dollar in more than a quarter of a century.

The strong pound means more good news for British tourists heading across the Atlantic but spells further pain for British firms trying to sell their products to the huge US market.

In frantic afternoon trading, the pound pushed up to $2.0174, breaking the 26-year high of $2.0133 set in April.
The move was supported by a growing feeling that interest rates in Britain are heading up to 5.75% on Thursday and maybe to 6% within months, making sterling-based assets more attractive than ones in the US, where analysts think problems in the housing market could eventually force the Federal Reserve to cut the bank rate from 5.25%.

With Britain already having the highest rates in the Group of Seven leading economies, hot money is flowing into sterling.

The dollar also fell to within one cent of a record low against the euro, at $1.36, extending heavy losses suffered on Friday after soft data on US consumer price inflation and personal income and spending encouraged the belief among investors that the Fed would not be raising rates soon.

Concerns about the US sub-prime mortgage market - amplified over the past week by trouble at two Bear Stearns-managed hedge funds - have also dented investors' appetite for risk.

"Basically we are seeing a continuation of dollar selling after the soft data we saw last week," said Boris Schlossberg at DailyFX.com in New York. "It all dovetails into the theme that the ECB [European Central Bank] and BoE are going to be much more aggressive raising rates than the Fed."

The ECB has raised rates for countries using the euro to 4% and is expected to raise them further.

The dollar's broad decline against all currencies was not even halted by a stronger than expected report on the country's manufacturing sector from the Institute of Supply Management.

"Manufacturing is rebounding," said Nigel Gault, an analyst at Global Insight. "In the first quarter, manufacturers were reporting that their customers had too much inventory on hand; now they are reporting that customers have too little inventory. So orders are now rising and driving production higher."

The speculation that the Bank of England will put up interest rates this week was bolstered by a survey from CIPS/NTC yesterday showing that while activity in Britain's factories slowed slightly last month, price pressures remained strong.

The CIPS/NTC purchasing managers' index fell to 54.3 in June from a downwardly revised 54.7 in May. Any figure above 50.0 denotes expansion.

But raw material costs rose at their strongest for nine months while the output price index eased marginally to 56.8 but remained close to the historic high seen recently.

The figures chime with other surveys showing that firms remain confident about their ability to raise prices and this is likely to swing the argument on Thursday to raise borrowing costs to a seven-year high of 5.75%.

"The continued strength of the prices-charged balance of the UK CIPS/NTC report on manufacturing will provide further ammunition to the hawks at this week's meeting," said Jonathan Loynes at Capital Economics.

But there were signs that demand in the UK is subsiding, with the total new orders index slipping to 54.7 from 55.5 in May to reach its lowest since January.

The strong pound does not so far appear to have dented demand for British goods abroad, with the survey's export orders index rising to 54.0 from 53.6.

Analysts said, however, that the pound could fall sharply if the MPC voted against another hike this week.

"Thursday is a big focus - it's almost fully priced in," said Rabobank's senior proprietary trader Lee Ferridge. "The risk to sterling is probably one way. If the Bank doesn't go [for a hike] that would be a major surprise and would hurt sterling."