Sterling bumps against ceiling as rates stay put

The pound bumped up repeatedly against its old lower limit in the exchange rate mechanism without breaking through in the 24 hours up until trading closed in London yesterday.

The currency's thwarted bid to pass the psychological barrier of DM2.78 came as all the signs were that Kenneth Clarke, Chancellor of the Exchequer, had resisted Bank of England advice at yesterday's monetary meeting to raise interest rates.

"Sterling has been up against the ceiling several times in the past 24 hours without quite making it," said Simon Briscoe, UK economist at Nikko.

Neil MacKinnon at Citibank predicted that it was only a matter of time. "It will have another bash at testing the DM2.78 level in the very short term and will probably go beyond it."

The health of the British economy compared with the rest of Europe and investors' expectation that a Labour government will raise the level of interest rates after the general election help explain the strength of the pound.

Virtually none of the City experts thinks the Chancellor will increase the cost of borrowing before then. "The chance of a rate rise before the election is remote in the extreme," said Geoffrey Dicks at NatWest Markets.

"Any narrowing of Labour's lead in the polls would be seen as a negative for the pound," Mr MacKinnon said. In a reversal of the traditional pattern, the financial markets expect a tougher interest rate policy under Labour.

Investors also see a greater chance that a Labour government would take the pound into the single currency. That would diminish its current attractiveness as a safe haven from any possible turbulence related to the transition to European Monetary Union.

Economists foresee the exchange rate remaining strong until either British growth slows down or the Continent catches up. But one warned yesterday that the pound would be falling at a time when inflation would be on the increase anyway.

"The strong pound will begin to unwind next year, when it will reinforce increasing inflation," said Andrew Sentance, director of economic forecasting at the London Business School.

The economy's strong performance would lead to higher inflation, but with a long delay, he told a seminar at the National Institute of Economic and Social Research in London yesterday. He warned that there were "speed limits" on how fast the economy could grow without triggering inflation.

Although economists are divided over the need for a rise in interest rates now, a majority forecast that inflation will be above its 2.5 per cent target at the end of this year and next year. The higher exchange rate is expected to reduce inflation below what it would otherwise have been only in the short term.

The pound closed down slightly at DM2.7590 in London yesterday. After another strong start to trading on Wall Street, shares in London reached a new record with the FTSE 100 rising just over 2 points to 4,360.1. The Dow Jones closed up 93.13 points at 6945.85, after a 66-point fall in late trade on Tuesday.