Where next for the pound?

That sterling has hit a five-year high has raised questions at the Bank of England.

The pound's rebound on foreign-exchange markets has been one of the most closely watched trends over the past few months. Sterling has jumped to a five-year high against a basket of major trading partners' currencies on a trade-weighted basis (see chart).

It is at a two-and-a-half-year high of $1.64 against the US dollar, having gained more than 10% since last summer. Against the euro it has reached a 12-month high of €1.21.

The pound could now hurt growth by making exports expensive. The Bank of England worries that "any further substantial appreciation" could hamper the recovery. Clothing retailers Burberry and Asos warned that the strong pound was starting to affect their foreign sales.

The main driver of the currency's strength has been the turnaround in the economy. Recent data have been unexpectedly strong, and Britain's impressive growth has made markets look forward to eventual interest-rate hikes.

Only America, which is recovering even faster, is likely to raise rates before Britain, says Capital Economics. In Europe, monetary policy is likely to become even looser, if it changes at all.

675-sterling-broad-index

Surging house prices may also be fuelling anticipation of rate rises, to prevent a bubble. The Bank's governor, Mark Carney, "has been caught out by the strength of the labour market [and] appears to be making the same mistake with the housing market", says Larry Elliott in The Guardian.

But Carney could well keep a lid on sterling by lowering the unemployment target or making it clearer that rates won't rise for a long time, even if it hits 7%. The decline in inflation gives him more scope to keep rates lower longer than the markets anticipate, says Morgan Stanley.

Given this, and the fact that the US might raise rates before Britain, sterling will most likely weaken slightly against the dollar. With Europe still weak, it could make further, albeit unspectacular, gains against the euro.

Recommended

Why UK firms should start buying French companies
UK stockmarkets

Why UK firms should start buying French companies

The French are on a buying spree, snapping up British companies. We should turn the tables, says Matthew Lynn, and start buying French companies. Here…
28 Sep 2022
How the end of cheap money could spark a house price crash
House prices

How the end of cheap money could spark a house price crash

Rock bottom interest rates drove property prices to unaffordable levels. But with rates set to climb and cheap money off the table, we could see house…
28 Sep 2022
Hundreds of mortgage products withdrawn as interest rates surge
Mortgages

Hundreds of mortgage products withdrawn as interest rates surge

Hundreds of mortgage products have been withdrawn after sterling crashed to the lowest levels in decades against the dollar and the Bank of England sa…
28 Sep 2022
Which house-price index is the best?
Property

Which house-price index is the best?

Britain is obsessed with house prices, and we have at least four house-price indices to choose from to measure the rate of increase in the value of ou…
27 Sep 2022

Most Popular

Earn 4.1% from the best savings accounts
Savings

Earn 4.1% from the best savings accounts

With inflation topping 10%, your savings won't keep pace with the rising cost of living. But you can at least slow the rate at which your money is los…
27 Sep 2022
How much is King Charles III worth?
UK Economy

How much is King Charles III worth?

What will King Charles III inherit from the late Queen? Will he have to pay inheritance tax? And how large is his personal fortune and estate?
23 Sep 2022
Beating inflation takes more luck than skill – but are we about to get lucky?
Inflation

Beating inflation takes more luck than skill – but are we about to get lucky?

The US Federal Reserve managed to beat inflation in the 1980s. But much of that was down to pure luck. Thankfully, says Merryn Somerset Webb, the Bank…
26 Sep 2022