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Sterling rose to its strongest level in nearly three months against the dollar on rising expectations that the Bank of England would abandon its ultra-loose monetary policy stance and raise interest rates in the coming months.
The pound was lifted on Wednesday as the UK construction sector purchasing managers’ survey showed a strong rebound in activity in January, suggesting that the sector would return to growth in the first quarter of 2011.
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The news added to increased optimism over the UK economy, which was boosted on Tuesday after a survey suggested activity in Britain’s manufacturing sector rose to a 16-year high last month.
The pound found support against the dollar as the news lifted the spread of the yields of interest rate sensitive two-year gilts over two-year Treasuries to its widest level in two years, as expectations for a near-term rise in UK interest rates increased.
The spread of the yields of two-year gilts over two-year Japanese government bonds also hit its widest in two-years.
Valentin Marinov at Citigroup said sentiment towards sterling had improved dramatically from a week ago, when an unexpected drop in fourth-quarter UK gross domestic product fuelled investor concerns about the prospect of stagflation in Britain and the ability of the Bank of England to deal with high and growing inflation while the economic outlook remained uncertain.
“Sterling has been going from strength to strength recently on the back of renewed expectations of Bank of England hikes in the coming months,” he said.
Mr Marinov predicted the Bank would raise interest rates in the coming months, which would not just boost sterling but help solve its policy dilemma as it fought to contain inflation.
“Currency appreciation could prove the most effective tool to address the issue of imported UK inflation,” he said.
“We maintain our constructive view on sterling and expect it to remain bid across the board over the medium to long term.”
The pound rose 0.4 per cent to $1.6215 against the dollar, its strongest level since November 5, climbed 0.4 per cent to £0.8526 against the euro and was 0.6 per cent stronger at Y132.04 against the yen.
