Sterling hit a near-six-year high against a basket of currencies on Friday, helped by a fifth straight week of gains against the struggling dollar and against a euro weakened by fresh worries about the prospect of quantitative easing. In contrast with the dovish signals from the euro zone, the Bank of England looked clearly on track for a rate hike either later this year or early in 2015, leading to a widening in rate differentials between two-year British government bond yields and equivalent German Bunds.
On Thursday European Central Bank President Mario Draghi fleshed out the terms of the long term loans the ECB will offer to banks in coming months and kept the possibility of fighting disinflationary pressures with a large-scale asset purchase programme on the table. These measures would lead to an expansion of the ECB balance sheet that will see more euros flooding the system and driving down its value.
The common currency was down 0.15 percent against the pound , at 79.22, having hit a 22-month low of 79.18 pence earlier in the day. It was on track for its biggest weekly fall since mid-June. Against a trade-weighted basket of currencies, the pound edged up to 89 - its highest in almost six years. "Sterling is the new currency of choice," said Neil Mellor, a currency strategist at Bank of New York Mellon.
"For anyone using a funding currency like the euro or the dollar...you're looking to exchange it for a currency with good, solid fundamentals. There are only a few that really creep into that category at the moment - the Canadian dollar is one obvious one and sterling is another." The pound held its ground against the dollar, trading at $1.7150. Though the dollar rose against most other major currencies after unexpectedly good US jobs data, sterling was heading towards its fifth straight week of gains against the greenback for the first time in almost two years.
While data backed expectations that the US economy is recovering well after a weather-related dip in the first quarter, investors are wary of driving the dollar higher given the Federal Reserve is still likely to keep rates low for longer in the absence of any significant rise in wage inflation. Meanwhile in the UK this week, though data from the services sector fell short of expectations, both the manufacturing and construction sectors outperformed. House prices were shown to be rising at their fastest rate in nine years, while consumer confidence has also edged up.
All of that served to cement a view that the BoE will hike borrowing costs in the coming months. Investors are betting that will happen long before the Fed, helping to keep sterling supported above $1.70. "We expect the pound to remain supported by the encouraging UK growth picture, which remains broad-based. We have raised our recommended buying level to $1.7150 after narrowly missing getting long at the $1.7100 level yesterday. We maintain our $1.7400/1.7500 target," Morgan Stanley said in a note. But some traders were less confident about the prospect of a rate hike before the end of the year. They pointed out the lack of resistance levels between $1.70 and $1.80 could see the pound rally sharply.
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