Markets bet on new stimulus from Fed

Sterling is flirting with its highest levels against the US dollar in six months, as financial markets await today's latest ruling on interest rates from the Federal Reserve.

While the days of the $2 pound, which sent British shoppers scurrying to New York to take advantage of the favourable exchange rate, are long gone, the newfound strength reflects changed attitudes in the currency markets. While nerves over the progress of the economic recovery are frayed both in the US and the UK, currency traders have dialled back their bets against sterling and turned their attention to a string of disappointing data from the US.

Those disappointments have piled pressure on the Fed to respond with a stronger commitment to lowering market interest rates and stoking the economy. Ideas up for discussion at the Federal Open Market Committee meeting today include a modest extension to the programme of quantitative easing launched to alleviate the credit crisis last year, plus a new public statement on how long it might keep rates at near-zero levels.

The central bank is also expected to discuss downgraded economic forecasts for the US economy.

The pound, meanwhile, has been buoyed since a better reading for UK GDP in the second quarter, and has been hovering at the $1.60 mark it last saw in February. Yesterday, it was little changed at $1.5944, as of 5pm in London. Data from the US futures regulator shows speculators have cut back earlier large short positions in the pound, returning to a neutral position last week. But Daragh Maher, currency strategist at Credit Agricole CIB, said that significant gains above $1.60 may be difficult, unless there is a major surprise from the Fed. "We no longer have that short-covering scramble that certainly played its part in pushing cable up since June."

Robert DiClemente, chief US economist at Citigroup, said it was difficult to handicap the outcome of the debate inside the Fed. "It isn't clear if policymakers' forecasts will be revised sufficiently to warrant a new easing effort," he said. "The earlier focus on exit strategies probably dulled the credibility of the Fed's low rate commitment but highlights the difficulties of achieving policy success with unconventional strategies."