Sterling the new safe haven? Pull the other one

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The Independent Online
Sterling as a safe haven? Well there's a thing. And yet amazingly this is one of the reasons cited by traders for the present strength of the pound. By any stretch of the imagination this is a turn-up for the books. For 30 years or more, sterling has been a pariah currency, the sort of coinage you could pretty much guarantee to lose your money in over the long haul. Now, some believe, a new competitor is about to enter the ring for the title of weakling of Europe - the euro.

This is based on the idea that Maastricht will be fudged to a degree that will allow both Italy and Spain in from day one, in which case the euro might be expected to behave more like the lira and peseta than the Deutschmark. Until recently the markets had assumed that the Bundesbank line on the need to keep out the soft Mediterranean currencies would prevail. But now we have Italy and Spain in a mad dash to join EMU at its planned starting date of 1999. As a result, there is a growing prospect of a wider and more unstable single currency.

Meanwhile, the plucky little pound, standing bravely aloft from the euro, will take on the attributes of the Swiss franc as a currency that holds its value through thick and thin, an attractive haven for the rich and secretive. What we are witnessing, those who hold this view insist, is a sea change, with sterling climbing back to its pre-war position as one of the strongest currencies in the world.

And pigs might fly. While there are certainly signs aplenty that the British economy is kicking old habits, markets are going to take a little bit more convincing yet. Other explanations for sterling's strength are rather more mundane, short term and believable.

The first is that gilts look cheap against other European bonds, which in turn have been buoyed by the dash to the euro and German-style bond yields. For the next few months at least, sterling assets look attractive to foreign investors. And here's the second reason why sterling is showing strength; short-term interest rates in the UK are on the turn with the next move most definitely up, probably sooner rather than later. The very strength of the pound, the effect of which is to dampen the economy and inflation, gives the Chancellor a little more leeway than he had before, but even so there can be little question that he must raise interest rates again shortly. Third, there is the strong oil price, up very substantially over the past year; it is easily forgotten that Britain is still a net exporter of oil and gas.

For all the Chancellor's achievements, the UK's inflation rate remains above the EU average - well above it if Greece is excluded. Many economists, not just a hard-core of "sado-monetarists", think the current recovery will prove inflationary, if not as seriously so as the Lawson boom. The pound might be a good bet for several months, but it has not yet knocked the mighty mark off its pedestal. Sea changes do happen, every now and again a currency takes on a different kind of status, but such change rarely happens overnight. Certainly, sterling is not there yet.

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