MARKETS: CURRENCIES

THE POUND will probably hold gains against the euro and dollar this week as reports are expected that make the Bank of England more likely to raise interest rates in the months ahead.

The pound rose to its strongest level against the euro and hovered near a one-month high against the dollar this week in expectation of higher interest rates. Policy-makers left the benchmark repurchase rate at 5.5 per cent after lifting it twice since September by 50 basis points to maintain its 2.5 per cent inflation target.

"On balance, inflationary news will remain good but the accumulative evidence will show the economy growing rapidly, which means expectations for higher interest rates will remain and underpin sterling," said Paul Turnbull, the chief UK economist at Merrill Lynch. He expects a 25 basis- point rate increase by February and a top rate of 6 per cent by June.

Europe's single currency fell to a record low of 0.6233 per pound on Friday. Against the dollar, the pound was little changed at $1.6244. On Wednesday, it reached $1.6312, tracking the euro's rise against the dollar after upbeat German reports.

Higher interest rates would narrow the gap between US and UK deposit rates while widening the difference between pound and euro deposits. A three-month pound deposit offers 5.90 per cent, 30 basis points fewer than dollar deposits and 254 basis points more than its euro counterparts.

"UK growth does remain reasonably strong and non-inflationary," said Brian Martin, chief currency economist at Barclays Capital. And that provides "a positive backdrop for the pound" and interest rates.

"Sterling will perform well against the euro", with a push through record levels possible, he said. Against the dollar, the pound should continue to trade "between $1.61 and $1.63, though if we remain below $1.63 the bias is down".

Reports due include the retail price index (RPI), the Government's centrepiece measure of inflation, on Tuesday, following producer price indexes (PPI) on Monday.

Labour market and retail sales figures follow later in the week, along with a report from the Confederation of British Industry. "Unemployment figures on Wednesday will be watched closely, and RPI and PPI will be important," said Claudio Piron, a treasury economist at Standard Chartered Bank. "We'll see [job] vacancies shooting up sooner or later, and unemployment below 4 per cent could be uncomfortable."

The UK currency has climbed 12.4 per cent against the euro since its 4 January debut. Sterling has risen 1.4 per cent against the dollar in the past five days, mirroring the euro's gains in the same period.

The yen gained against the euro on Friday ahead of a Bank of Japan survey that could show increasing optimism among Japanese businesses, underscoring its investment appeal.

Improving Japanese business sentiment "will reassure people the recovery continues", and support Japanese stocks and the yen, said Craig Larimer, a currency strategist at Banc One Capital Markets.

The yen rose for the second day against the euro, to 103.905 and against the dollar, to 102.30 from 102.46. The dollar rose to $1.0123 per euro from $1.0214 after a report on US producer prices showed tame inflation, thereby boosting bonds.