Why sterling's glory will be brief

With recent rate rises and weak data from the US labour market, it looks as though sterling could break throught the $2 mark. But serious dollar weakness is unlikely.

Is sterling poised to break through the "mythical" $2 mark? asks Steve Johnson in the FT. The pound last reached those heights just before Black Wednesday in September 1992, and its time at the summit was brief and rapidly followed by an ignominious descent. But the quarter-point rise in UK interest rates, coupled with weak data from the US labour market, is giving the pound an extra spring in its step, while the dollar could take a further drubbing if the Federal Reserve's rate tightening cycle is at, or nearing, its end.

In fact, history suggests the greenback looks vulnerable against many currencies, says Allister Heath in The Business. Research by George Saravelos and Trevor Dinmore of Deutsche Bank into the outcome of previous tightening cycles implies that an end to rate hikes will hit the dollar. The result is unlikely to be a fall on a par with the 10% slump that happened after the end of a tightening cycle in February/March 1995, because at that point the markets expected significant further tightening and were shocked when it didn't materialise.

This time round, the market expects no or very few further increases, so traders are prepared for the cycle end and this could limit the immediate damage. "But the evidence suggests the greenback tends to be much more prone to other, non-monetary policy shocks, when the Fed is no longer in tightening mode." In other words, other factors, such as a worsening economy or trade deficit, could have a bigger effect on the dollar once the crutch of rising rates is kicked away.

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But could this presage the decline and loss of faith in the dollar that seems inevitable the point when everyone realises "the old girl ain't what she used to be", as MoneyWeek publisher Bill Bonner put it? Not yet, says Edward Hadas on Breakingviews.com. The IMF expects the dollar ultimately to fall by up to 35%, but for now it remains a safe haven, because it's the base currency for international trade. This may sound a shaky foundation, given the US's fundamentals, but central bankers and responsible investors don't want to shake confidence in the global currency so they'll keep buying US assets.Thus serious weakness is unlikely. That means that sterling's moment of glory could be brief especially since it's already as overvalued in purchasing power terms as it was in 1992, says Hans Redeker in the FT.

"Mugged by an Old Lady. How embarrassing," says Jamie Chisholm in the FT. UK equities and bonds took a beating last week after the Bank of England (BoE) otherwise known as the Old Lady of Threadneedle Street unexpectedly hiked interest rates by a quarter of a point.

The rise shouldn't have shocked the stockmarket as much as it did, says William Kay in The Sunday Times. Plenty of commentators had already said that it was a 50/50 bet on whether the BoE would be spurred into action. However, "investors have become used to central banks delicately managing expectations", says Chisholm. The European Central Bank's (ECB) decision on the same day was well-trailed yet the ECB has always been regarded as bad at communication, while the BoE is viewed as the most sophisticated of central banks in this respect, says the FT's Lex column.

The result of this surprise is that "its anti-inflation credentials have certainly been enhanced, but its reputation for intellectual consistency has not".

Gripes over the surprise aside, the real fear is that rates will rise substantially higher. It could be that the BoE will make only one more increase in the cost of borrowing, says The Times. But any consumers who would be badly hurt if rates climbed above 5% should expect the worst and reorganise their finances accordingly. And if people heed this sage advice, it does not bode well for shares, says Kay especially those in the retail sector and other businesses reliant on consumer spending.

by Graham Buck