Sterling hit a 7-1/2-year high against a trade-weighted basket of currencies on Thursday as traders bet the Bank of England would raise interest rates early next year, while euro zone monetary policy remains ultra-loose. After Greece's parliament approved an austerity plan demanded by its creditors in the early hours of Thursday, investors shifted their focus away from the Greek drama and back towards the diverging policy outlook for the European Central Bank and its UK and US peers, sending the euro lower across the board.
That diverging outlook was crystalised this week, with Bank of England Governor Mark Carney saying a first rise in interest rates since the 2008 financial crash was "moving closer", and US Federal Reserve Chair Janet Yellen reiterating that a rate hike was on the cards this year. Carney, who also played down the impact of a strengthening pound on inflation, helped pull money-market pricing for a UK hike in to the first quarter of next year. Such a move had not previously been expected until May or later.
"Carney hasn't been particularly vocal when it comes to deciding on interest rates, whereas in this instance he has, so that was always going to give sterling a boost," said Angus Campbell, senior analyst at forex broker FxPro. "And when you consider the euro, it's still fundamentally quite a weak currency - that's going to shift sterling to the upside." The single currency traded at as low as 69.64 pence on Thursday, its weakest in over 7-1/2 years. That help the BoE's trade-weighted sterling index to reach 94.2, its strongest since March 2008.
Against the dollar, the pound was 0.3 percent down at $1.5599. Carney's comments earlier in the week followed an uncharacteristically hawkish message from BoE monetary policy committee (MPC) member David Miles, who said the idea the BoE had to wait for the Fed to raise rates was "daft". But some strategists reckon that whatever is said in public, the BoE will not risk tightening policy, and potentially stifling growth, before US rates have started to increase.
"If the market firms up expectations of a 2015 Fed lift-off, it can also bring forward expectations of the first UK MPC hike," wrote Societe Generale strategists in a research note. "MPC members are sending a clear message that the time for hikes is approaching and there's less in the UK rate curve than the US one."
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