UK pound set for biggest annual gain

The pound is headed for its biggest annual advance since 1990 as it became the world's third-most popular reserve currency.

'Dollar weakness manifests itself through the pound more than the euro because there is no verbal intervention factor in the UK,' said Neil Jones, head of European hedge fund sales in London for Mizuho Financial Group Inc, Japan's second-biggest lender. 'We are looking for the pound to hit US$2...

UK pound set for biggest annual gain in 16 years  Bloomberg news 29 Dec 2006

(LONDON) The pound is headed for its biggest annual advance since 1990 as it became the world's third-most popular reserve currency and the Bank of England lifted interest rates to their highest in five years.

 

Britain's currency has risen 14 per cent versus its US counterpart this year after the central bank unexpectedly raised borrowing costs in August and increased them again last month. The pound has also gained against 15 of the 16 most active currencies tracked by Bloomberg and is now four cents shy of the US$2 milestone, which it last touched 14 years ago.

 

'Inflation and inflation expectations in the UK have picked up once again,' said Hans Guenter Redeker, head of currency strategy in London at BNP Paribas SA. 'We expect sterling to remain well supported in the first half of 2007.'

 

Against the dollar, the pound was at US$1.9658 by 2pm in London from US$1.7187 on Dec 30. The annual gain of almost 14 per cent is its biggest since 1990, when it surged 19 per cent versus the dollar. The pound is set to gain for a second year versus the euro, trading at 67.09 pence from 68.85 on Dec 30.

 

Two-year gilts, the securities most sensitive to interest-rate expectations, are set to drop this year by the most since 1999. The yield on the two-year note has risen 100 basis points in 2006 to 5.19 per cent. The price of the 5 per cent gilt due March 2008 was at 99.77.

 

The pound may also be boosted after a report yesterday from Nationwide Building Society showed UK house prices rose in December for a 10th month, pushing the annual rate of property price inflation to the fastest pace since January 2005.

 

The central bank said on Nov 9 it expects inflation to 'rise further above target in the near term, but then fall back as energy and import price inflation abate'. Bets by traders on a further interest-rate increase by the Bank of England are also helping boost the pound.

 

Interest-rate futures trading shows investors expect the central bank to lift rates once more by the end of the first quarter next year.

 

The implied yield on the March 2007 contract was at 5.47 per cent yesterday. The contracts settle to the three-month London inter-bank offered rate for the pound, which averaged about 15 basis points more than the benchmark rate for the past decade.

 

'We continue to look for a February hike of 25 basis points, and data on retail sales and earlier upside surprises on inflation have both increased the probability we'll be right,' said Daragh Maher, a currency strategist in London at Calyon, the investment banking unit of Credit Agricole SA. 'A rate hike is already virtually priced in.'

 

The pound has also gained as central banks have added more of the currency to their reserves this year to take advantage of the higher returns on assets denominated in the UK currency.

 

The pound surpassed the yen in December as the world's third-most popular reserve currency, behind only the dollar and the euro. Central banks lifted holdings of pounds to US$115 billion, or 4 per cent of total reserves at the end of March, the highest since at least 1999, International Monetary Fund data showed in June.

 

Europe's second-largest economy grew at the fastest annual pace in two years in the third quarter and has shown few signs of slowing even after the two interest-rate increases from the Bank of England. Rising retail sales, surging house prices and a recovery in manufacturing means the economy will exceed the government's growth forecast of between 2 and 2.5 per cent this year, Chancellor of the Exchequer Gordon Brown said on Nov 27.

 

On Dec 12, a report showed consumer-price inflation in the UK economy quickened to the fastest rate in more than nine years, causing the pound to rise by the most in three months versus the euro.

Now analysts expect the pound to reach US$2, a level it last reached 14 years ago, buoyed by a weaker dollar that has been hurt as speculation mounts a slowdown in the US economy will prompt Federal Reserve policy-makers to start lowering interest rates next year.

 

The pound on Dec 1 touched its highest since September 1992, when speculators led by billionaire investor George Soros drove the UK currency out of Europe's system of linked exchange rates.

Britain's withdrawal from the European Exchange Rate Mechanism triggered a 20 per cent drop in the pound over the next three months and Soros made US$1 billion from his wager, earning the nickname 'the man who broke the Bank of England'.

 

'Dollar weakness manifests itself through the pound more than the euro because there is no verbal intervention factor in the UK,' said Neil Jones, head of European hedge fund sales in London for Mizuho Financial Group Inc, Japan's second-biggest lender. 'We are looking for the pound to hit US$2.' - Bloomberg