News Column

Sterling close to five-year high against dollar: $1.70 barrier broken after Carney's rate rise hint Middle East crisis triggers surge in crude oil prices

June 17, 2014

Katie Allen



The pound climbed to a near five-year high against the dollar yesterday as markets reacted to the prospect of an interest rate rise before Christmas.

Sterling broke through $1.70 for the first time since August 2009 during a volatile day for financial markets that saw the Iraq crisis spur a rise in the oil price and a shares sell-off across Europe.

After the Bank of England governor, Mark Carney, said last Thursday that borrowing costs could rise from their record low sooner than markets expected, investors have been scrambling to reposition for an increase this year. Attention is now turning to the publication tomorrow of minutes from the Bank's latest rate-setting meeting, with some commentators saying they may even show that one member of the nine-strong committee pushed for a rate rise from 0.5% this month.

Although some economists had predicted the Bank might have to raise interest rates in 2014 as the economy gathers steam, Carney had until now repeatedly played down speculation of a hike this year. Chris Turner, strategist at ING, commented on the U-turn: "Now we are told to expect a rate increase sooner rather than later. Such dramatic changes in the BoE view are much more in line with where we see the UK economy, but do give the impression of a central bank which has been running behind the curve."

The pound rallied on Carney's remarks and yesterday added to gains as speculation grew that talk of rate hikes in the minutes was what prompted the change of tune. At one point the pound hit $1.7011, although it later fell back to $1.6984.

The movement in sterling is good news for holidaymakers before the peak summer season, but a hindrance for British exporters, who are in the vanguard of George Osborne's manufacturing-led "march of the makers". The strength of sterling has stemmed from the contrasting outlooks between the UK and other advanced economies, where central banks are seen to be waiting longer before ending the ultra-loose policy put in place during the financial crisis.

The US Federal Reserve meets this week and investors will be looking for clues to when it will start to raise rates from 0.25%.

"Wednesday's Bank of England minutes and Federal Reserve policy announcement could prove pivotal for sterling," said Nawaz Ali, UK market analyst at Western Union Business Solutions.

"If the two updates highlight the increasing policy divergence between the two central banks, pounds /$ [exchange rate] could finally make a sustained break through the critical $1.70 barrier, which could then potentially open up a move towards the $1.7100 to $1.7250 range."

The pound also managed some short-lived gains against the euro. It hit a 20-month high of 79.59p before easing back to around 79.85p against the European single currency, which has come under pressure as the European Central Bank loosens policy to tackle worryingly low inflation.

Further support for the pound came from remarks by retiring Bank deputy governor Charlie Bean. He reinforced speculation of a rate rise before the end of the year by telling the Sunday Times that a move would be "a symbolic step, because it will be an indication that we are on the road back to normality". He added: "Frankly, having interest rates at an emergency level for a very long time is not a situation one wants to be in."

Financial markets have now fully priced in a hike by the end of 2014 but analysts are divided over how soon and how far borrowing costs go up again after that first move. Many predict the strength of sterling will make the Bank cautious. Policymakers at the Bank have stressed that when they raise rates, they will do so only gradually.

"A late-2014 rate increase does not necessarily mean we should not expect a second move to occur so quickly," said Peter Dixon, economist at Commerzbank.

"For one thing, the BoE will not wish to put too much upward pressure on sterling given that the Fed is unlikely to move until the spring and the ECB is also conducting a policy of aggressive easing."

Elsewhere in financial markets, oil prices rose as the crisis in Iraq raised supply fears. Brent crude rose as high as $113.28 before ceding some ground to stand at $112.98 around the time of the London market's close. Geopolitical tensions also saw shares fall across Europe, with London'sFTSE 100 index of bluechip stocks closing down 0.3% at 6,754.6.

Captions:

The higher pound will squeeze exporters such as luxury car maker Bentley Photograph: Christopher Furlong/Getty Images



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Source: Guardian (UK)


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