Comment: Two views on why the pound is so strong

One of the deepest mysteries of the financial markets is why exchange rates move the way they do. There are two mainline views on why the pound is as strong as it is. One predicts that sterling will fall back sooner or later because its strength simply reflects the fact that the UK is at a more advanced stage of its interest rate cycle than other European economies. Demand in Britain is booming, and interest rates will probably climb for another 12 months. Although the big continental economies are starting to recover, few analysts think they will raise rates before the end of this year.

That makes sterling a decent one-way bet for currency traders, for the time being at least. But the position will flip when the UK economy starts its downturn ahead of its trading partners - perhaps by the middle of next year. British interest rates will start falling while European rates are still heading up.

Ebbing and flowing prospects for the single currency complicate this outlook. When EMU starts to look less likely, the Deutschmark gains at the expense of the pound. However, this undercurrent - the idea of sterling as a safe haven - probably has less impact on exchange rates than business cycle fundamentals.

The main alternative explanation for the super, soaraway pound is that the British economy is stronger and more competitive than it used to be. Businesses have emerged from two harrowing recessions in a lean, mean and competitive state. International investors have therefore re-evaluated Britain's economic prospects and the strong pound is an expression of their vote of confidence.

If this is the explanation, the pound will stay high and there is no relief in prospect for industry. The problem with this theory is that if true, our commerce shouldn't need any relief. If a strong exchange rate is simply a reflection of industrial strength, as the strong Deutschmark in the past mirrored the might of German industry, it is not going to bring British business to its knees.

So although there is a genuine policy dilemma for the Bank of England, in the sense that it would be preferable not to have had a 20 per cent exchange rate appreciation in less than a year, the dilemma is not as acute as many commentators suggest. In any case, a single decline in the notoriously erratic figures for manufacturing output should not tilt the balance away from the next increase in base rates when all the other indicators suggest that industry is still holding its own, while consumers are dancing all the way down the high street.

Start your day with The Independent, sign up for daily news emails
PROMOTED VIDEO
News
ebooksNow available in paperback
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Sheridan Maine: Regulatory Reporting Accountant

Up to £65,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Ashdown Group: Marketing Services Manager - (communications, testing, DM)

£32000 - £35000 per annum + benefits: Ashdown Group: Marketing Services Manage...

Guru Careers: Finance Account Manager

£Neg. (DOE) + Excellent Benefits: Guru Careers: A Finance Account Manager with...

Ashdown Group: Java Developer - Hertfordshire - £47,000 + bonus + benefits

£40000 - £470000 per annum + bonus: Ashdown Group: Java Developer / J2EE Devel...

Day In a Page

Homeless Veterans appeal: 'You look for someone who's an inspiration and try to be like them'

Homeless Veterans appeal

In 2010, Sgt Gary Jamieson stepped on an IED in Afghanistan and lost his legs and an arm. He reveals what, and who, helped him to make a remarkable recovery
Could cannabis oil reverse the effects of cancer?

Could cannabis oil reverse effects of cancer?

As a film following six patients receiving the controversial treatment is released, Kate Hilpern uncovers a very slippery issue
The Interview movie review: You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here

The Interview movie review

You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here
Serial mania has propelled podcasts into the cultural mainstream

How podcasts became mainstream

People have consumed gripping armchair investigation Serial with a relish typically reserved for box-set binges
Jesus Christ has become an unlikely pin-up for hipster marketing companies

Jesus Christ has become an unlikely pin-up

Kevin Lee Light, aka "Jesus", is the newest client of creative agency Mother while rival agency Anomaly has launched Sexy Jesus, depicting the Messiah in a series of Athena-style poses
Rosetta space mission voted most important scientific breakthrough of 2014

A memorable year for science – if not for mice

The most important scientific breakthroughs of 2014
Christmas cocktails to make you merry: From eggnog to Brown Betty and Rum Bumpo

Christmas cocktails to make you merry

Mulled wine is an essential seasonal treat. But now drinkers are rediscovering other traditional festive tipples. Angela Clutton raises a glass to Christmas cocktails
5 best activity trackers

Fitness technology: 5 best activity trackers

Up the ante in your regimen and change the habits of a lifetime with this wearable tech
Paul Scholes column: It's a little-known fact, but I have played one of the seven dwarves

Paul Scholes column

It's a little-known fact, but I have played one of the seven dwarves
Fifa's travelling circus once again steals limelight from real stars

Fifa's travelling circus once again steals limelight from real stars

Club World Cup kicked into the long grass by the continued farce surrounding Blatter, Garcia, Russia and Qatar
Frank Warren column: 2014 – boxing is back and winning new fans

Frank Warren: Boxing is back and winning new fans

2014 proves it's now one of sport's biggest hitters again
Jeb Bush vs Hillary Clinton: The power dynamics of the two first families

Jeb Bush vs Hillary Clinton

Karen Tumulty explores the power dynamics of the two first families
Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups

Stockholm is rivalling Silicon Valley

The Swedish capital is home to two of the most popular video games in the world, as well as thousands of technology start-ups worth hundreds of millions of pounds – and it's all happened since 2009
Did Japanese workers really get their symbols mixed up and display Santa on a crucifix?

Crucified Santa: Urban myth refuses to die

The story goes that Japanese store workers created a life-size effigy of a smiling "Father Kurisumasu" attached to a facsimile of Our Lord's final instrument of torture
Jennifer Saunders and Kate Moss join David Walliams on set for TV adaptation of The Boy in the Dress

The Boy in the Dress: On set with the stars

Walliams' story about a boy who goes to school in a dress will be shown this Christmas