Pound surges after American rate rise

The pound surged yesterday in the aftermath of the first increase in US interest rates for two years. Investors expect that the strong economy will force rates up on this side the Atlantic too, although probably not until after the election.

Better-than-expected trade figures and a very successful auction of gilt- edged stock yesterday also helped boost the pound against both the German mark and the dollar.

During the day it passed the DM2.75 level for the first time in three weeks, ending about a pfennig higher at DM2.7497. Against the dollar it gained just over half a cent to reach $1.6190.

"It's just a matter of time before the UK has to put up rates after the Fed's move," said Jeremy Hawkins, chief economist at the Bank of America.

The Federal Reserve said it had decided to raise the cost of borrowing by a quarter point "in light of persisting strength in demand, which is progressively increasing the risk of inflationary imbalances".

This is exactly the reasoning behind the Bank of England's advice to increase UK base rates, which has been so far refused by the Chancellor, Kenneth Clarke.

Trade figures yesterday showed little sign that the strong pound had affected the balance of payments in January.

The whole world deficit in trade in goods narrowed from pounds 825m in December to pounds 641m, the best monthly figure for more than a year.

However, the non-European Union deficit widened last month, to pounds 554m from pounds 339m in January. Economists saw this as a sign of the underlying deterioration in Britain's trade position due to the strength of the currency.

"These figures are just flattering to deceive," said David Walton, an economist at the investment bank Goldman Sachs.

City analysts warned that the trade numbers would worsen as the year progressed.

There was evidence for this in the growth of underlying export and import volumes. In the year to January, exports grew by 5.9 per cent and import volumes by 8 per cent. Imports have picked up as exports have slowed.

The improvement in the headline figures is most likely due to what economists call the "J-curve" effect - the fact that a strong pound reduces sterling import prices before the full effect on trade volumes feeds through.

The Fed's move was justified by figures yesterday showing another big jump in durable goods orders in the US last month.

They increased by 1.5 per cent in February, following a 4.1 per cent jump the previous month. Much of the rise came in orders for electrical equipment.

"The Fed may feel compelled to raise rates again at the FOMC meeting in late May or early July," warned Christopher Low of HSBC Markets in New York.