Economists expect a rate increase as soon as next month, as evidence mounts that wages, retail prices and consumer demand are accelerating quickly enough to convince the central bank to raise rates for the seventh time in a year.
"The perception is that interest rates are likely to go up, and that is sterling supportive," said Paul Griffiths, head of global fixed income at Invesco Asset Management. "We could see a bit more strength next week."
On Friday, the pound rose as high as 3.0226 marks, its strongest since 20 April. It broke 3.0 marks for the seventh consecutive day, after spending more than six weeks below that level. Against the dollar it rose to $1.6600, from $1.6700.
The prospect of higher rates bolsters the pound, boosting the money market return for sterling investors. For example, three-month sterling deposits pay 7.81 per cent, while mark deposits pay 3.56 per cent and dollar deposits 5.69 per cent.
The pound has risen 27 per cent against the currencies of its main trading partners in the past two years, boosted by six quarter-point rate increases since May 1997.
The benchmark interest rate now stands at 7.50 per cent, the highest in five and a half years.
Since the Bank of England's Monetary Policy Committee unexpectedly raised interest rates on 4 June, the pound has risen more than 10 pfennigs against the mark. The minutes of the June meeting have not yet been published but there was speculation last week that the vote was seven-to-two for an increase. In May, before the committee reached its full strength of nine members, six members voted to keep rates on hold and one voted to cut rates.
"It's clear from what Eddie George [Governor of the Bank of England] has been saying that he voted for a rise," said Mike Metcalf, a currency strategist at NatWest Global Financial Markets.
Mr George said earlier this week that higher wages combined with price rises in the service industry pose the biggest threat to the central bank's ability to get annual inflation down to the Government's 2.5 per cent target, from 3.2 per cent in May.
Investors and traders are speculating that a majority on the committee will vote to raise rates again at the next session on 8 and 9 July.
The yield on the September short sterling futures contract, a measure of interest rate expectations, rose two basis points to 7.95 per cent, suggesting that many investors think rates will rise by the end of the third quarter.
The central bank "may refrain from raising rates in July, but they'll probably rise in August," said Mr Metcalf, which means sterling "will stay around 2.98 to 3.02 marks for the next few weeks".
The dollar surged to its biggest gain against the mark in three months as Russian markets fell, souring investors on Germany, Russia's biggest lender and trading partner. On Friday, the dollar was trading at 1.8142 marks. In a further sign of Russia's dire straits, the central bank raised its key interest rate to 80 per cent from 60 per cent from tomorrow to stem the flow of cash out of the country. That helped the dollar extend its gains against the mark.
Copyright: IOS & BloombergReuse content