LONDON: Sterling held firm on Wednesday, hovering around its highest level in nearly five years against the dollar amid increased expectations among investors that the Bank of England may have to tighten policy sooner rather than later.
The BoE's monetary policy committee starts a two-day meet on Wednesday, with a slew of upbeat activity data and a rise in house prices piling pressure on it to lift interest rates from record lows of 0.5 percent.
Those expectations have widened interest rate differentials between British government bond yields over their US and euro zone counterparts, drawing more investors and speculators to the British pound.
Sterling was firm at $1.6980, having risen to $1.6996 on Tuesday with bulls targeting $1.70, a level last seen in August 2009. Sterling, on a trade-weighted basis, rose to its highest since late 2008 of 86.9, and up nearly 12 percent since lows struck in March 2013.
The gains come as data continued to surprise on the upside.
In April, the services purchasing managers' index rose to 58.7 from 57.6 in March, far above the 50 threshold for growth and beating forecasts of an unchanged reading.
The data followed a strong showing in the manufacturing sector too, pointing to a firm start to the second quarter.
Some economists are expecting the UK economy to grow at more than 1 percent, quarter-on-quarter.
In the first quarter, British growth was 0.8 percent, picking up from 0.7 percent in the fourth quarter of 2013.
That put it on course for a 3.1 percent expansion year-on-year.
In comparison, the US economy barely grew in the first quarter.
"The pound is continuing to strengthen, supported by the ongoing strength of the cyclical economic recovery in the UK, which is prompting the market to bring forward expectations for the first BoE rate hike to early in 2015," said Lee Hardman, currency analyst at Bank of Tokyo Mitsubishi.
Sterling overnight interbank average rates - the very short-term interest rates which form the basis of lending costs to the wider economy - are pricing in the chance of the first rate hike in the first quarter of 2015. A Reuters poll of economists still expects the first rate hike by the BoE in the second quarter of 2015. The dollar's woes were also helping the pound.
The greenback struggled and US bond yields remained subdued as investors braced for the possibility of dovish comments from Federal Reserve Chair Janet Yellen later in the day. FROTHY HOUSING SECTOR
The BoE's two-day meeting is the committee's first at which the members will discuss a wide array of indicators, not just the jobless rate, to determine how the economy is performing before deciding on interest rates.
Many economists argue that Britain's upturn is largely a matter of rising house prices in a small number of cities, fuelling the same sort of bubble that preceded the financial crisis of 2007-8.
The BoE is likely to address the issue in next week's quarterly inflation report. BoE deputy governor John Cunliffe said recently it would be dangerous to ignore the momentum of rising house prices.
As a result, many now speculate that certain prudential steps may be in store that could potentially delay the rise in rates that markets have priced in.
"In theory, such a move would reduce the possibility of rate rises because the pressure is taken off the Bank. But near-term it could be taken as sterling-positive because it would be seen as a sign from the authorities that the housing market is doing too well," said Simon Smith, an economist at FXPro.
Sterling was also firmer against the euro on Wednesday. The common currency was down at 82 pence, having hit a two-month trough of 81.93 earlier in the day.
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