MercoPress. South Atlantic News Agency

Sterling closing in on US$2 mark

Sterling moved tantalizingly close to the US$2 level yesterday after the pound hit a 14-year high for a second day against a battered dollar, as the prospect of a narrowing US interest rate gap haunted the greenback.

The pound has been one of the best performers against the dollar this year, fuelled by inflation-busting Bank of England rate hikes, inflows from mergers and acquisitions, and central bank reserve purchases.

Weaker than expected UK factory activity data knocked sterling briefly away from the peaks yesterday, prompting a bout of profit-taking from this week's hefty buying, but the pound rallied sharply in the wake of weaker than expected US manufacturing activity data.

The Institute for Supply Management survey of national manufacturing, the ISM index, had its lowest reading since April 2003 at 49.5, raising talk of a US interest rate cut from the current 5.25 percent.

"Effectively we've only had one week's worth of breakout from incredibly tight trading ranges over the past seven months in the major currency pairs ? this momentum may continue over the next couple of weeks," ING analyst Chris Turner said.

"We have a major new bearish factor today in the US ISM going sub-50. I think the market will be interested to see if Fed rhetoric switches from concern over higher prices to treating the downturn more seriously," he added.

Dealers' and analysts' bullishness on the pound achieving US$2, not seen since Britain was forced to abandon Europe's pre-euro Exchange Rate Mechanism in September 1992, has been fuelled by the euro making successive 20-month highs against the dollar.

By late afternoon, sterling had hit $1.9847, up one percent on the day. Against the euro, the pound was flat at 67.29 pence, off an earlier three-week high.

The rise in the Bank of England's trade-weighted index came after BoE governor Mervyn King sounded a sanguine note on sterling's strength on Thursday, pointing out its stability against the broader basket of currencies.

Robust euro sentiment has been built on expectations for the European Central Bank to raise interest rates beyond 3.25 percent.

After robust housing figures from the Nationwide Building Society on Thursday proved the final catalyst in taking sterling to the 1992 highs, investors had looked closely at yesterday's UK factory activity data.

The CIPS/RBS Purchasing Managers Index unexpectedly fell to 52.6 in November from a downwardly revised 53.5 in October to record the lowest reading since March and confound analysts' forecasts for an improvement to 54.0.

"The drivers of the fall in activity were fairly broad-based, with slower rates of growth seen in employment, output and new orders. But with the levels of the output and orders balance pointing to reasonably firm growth, it's important not to strike an overly pessimistic note," Barclays Capital analysts said in a note to clients.

Some analysts had said the UK manufacturing data reinforced expectations for the Bank of England to leave rates unchanged at 5.00 percent next week and in the early months of next year.

Economists polled by Reuters this week said UK interest rates have likely peaked and will probably stay on hold next year as growth eases and inflation falls, but any signs of higher wage deals could still prompt a rate rise early in 2007.

"The BoE is probably not going to hike rates but you still have a high yield. The pound looks quite attractive," said Johan Javeus, currency strategist at SEB in Stockholm. (Agencies)