The pound has risen 11 per cent against the euro this year, even as the Bank of England trimmed interest rates. Worse than expected growth in the euro region and concern that the war in Yugoslavia will swell euro nations' budget deficits have eroded the value of the five-month old common currency. "Sterling will remain strong," said Adam Chester, an economist at Halifax. "What's driving sterling higher are the problems facing the euro. Five months in and it's all gone wrong."
On Friday, the pound climbed as high as 0.6401 per euro, equivalent to about DM3.05, its highest since April 1998. Against the dollar the pound was little changed at $1.6065.
The Bank of England's Monetary Policy Committee (MPC) meets for its monthly interest rate decision on Wednesday and Thursday, and a decision to leave the benchmark interest rate unchanged at 5.25 per cent could further buoy the pound.
Unchanged rates mean the pound keeps its lucrative return. Three-month pound deposits currently return about 24 basis points more than dollar deposits and 270 basis points more than euro deposits.
Signs that the UK is rebounding may persuade the policy makers to leave rates unchanged. Reports last week have shown the bank's 2.25 percentage points of rate cuts in the last eight months are helping to boost growth, with house prices rising, optimism about retail sales improving, and service industry activity picking up.
Thirteen of 17 economists surveyed said policy makers at the central bank will keep rates on hold. Four said the bank will cut the benchmark rate to 5.00 per cent.
In one sign that investors increasingly expect the Bank of England to leave rates untouched, the implied yield on the September short sterling futures contract has risen about 7 basis points in the past week. It anticipates three-month rates at 5.27 per cent in September, close enough to current rates of 5.38 per cent to suggest few investors expect rates to fall. "Our view is for no change," said Sean Shepley, a strategist at Credit Suisse First Boston. "We've had further signs of growth."
More details on the state of the economy will come as the British Retail Consortium releases its retail sales survey for May on Tuesday, and the Government releases its report on manufacturing and overall industrial production on Wednesday. These figures are expected to show that industrial production and manufacturing production rose 0.2 per cent in April from the previous month.
Still, even as optimism about growth improves, the central bank may trim rates to keep inflation on target. The pound's strength threatens to knock inflation - as measured by the rise in retail prices minus mortgage interest payments - off the Government's 2.5 percent goal.
The vote of Sushil Wadhwani, who will attends his first MPC meeting since replacing Alan Budd, increases the likelihood of a rate cut as he's seen as favouring lower rates to keep inflation on track. Thursday's decision "will be finely balanced", said Mr Chester at Halifax.