Bank of England Governor Eddie George said surging wages earlier this year precipitated the recent quarter-point rate increase that took the benchmark lending rate to 7.50 per cent, a high since 1992.
The prospect that rates will remain at that level, or even rise, could boost the pound since higher rates mean a better money-market return on sterling deposits. Germany's benchmark rate, in contrast, is at 3.30 per cent.
"The Bank of England does not yet know how high is high enough, so these reports will be quite important," said Paul Chertkow, head of global currency research at Bank of Tokyo-Mitsubishi, who sees sterling rising to 2.96 marks in the days ahead. "Even if UK rates don't go up again this year, the gap between German and U.K. rates would be very substantial."
The pound was at 2.9446 marks on Friday and at $1.6314, little changed from $1.6305.
Economists forecast that a report on Wednesday will show average earnings accelerated by 5.1 per cent in March, extending a 4.9 per cent surge in March that helped convince the Bank of England to raise rates for a sixth time in 13 months. Those rate increases helped boost sterling 23 per cent against a trade-weighted currency basket since mid-1996.
"Until lower earnings growth is confirmed we expect the pound to remain relatively well supported against the mark," said Brian Martin, chief currency economist at Barclays Capital. Last week's rate rise boosted the money-market return on three-month sterling deposits to 7.69 per cent. That's 4.12 per cent higher than a three-month deposit in marks.
An inflation report in Germany on Friday suggested that rates there won't rise closer to UK rates in the immediate future. German consumer prices rose 0.3 per cent in May, unchanged from the month before.
Even as economists look for higher wages, many of them don't expect another rate increase. Only two of 21 economists polled recently said interest rates would go higher this year. Twelve forecast rates to be unchanged by the year's end, while seven predict a quarter-point cut by then.
"The reality is that wages won't be as bad as we think and that any rise in the pound will be short-lived," said Colin Harte, head of bond investment at Gartmore Investment Management. "People need to look behind the numbers and determine if March bonuses distorted the figures."
The dollar hovered near eight-year highs against the yen after Japan said its economy shrank for a second consecutive quarter, fuelling concern that other nations in Asia are headed for recession. "Everything on an economic basis points to a weaker yen," said Jay Bryson, an international economist at First Union Corp. "The dollar will continue to go higher, but we're getting to a real possibility that the Bank of Japan will step in" and sell dollars to support the yen. Those concerns capped the dollar's gain against the yen last week at 3.2 per cent.
Copyright: IOS & BloombergReuse content