In the past six months, sterling has gained 5% and 8% against the euro and dollar, respectively.
A rising interest-rate differential has been crucial. Forward markets now price sterling three-month interest rates in one year?s time at 4.8%, up 130 basis points since the Bank of England?s Monetary Policy Committee (MPC) last cut rates in July 2003. Eurozone forward rates have fallen 30bp in that time to 2.2%. So the yield spread is now 260bp.
It is likely to widen. The job of the MPC has been complicated by the UK government?s decision to adopt the EU-harmonized consumer price inflation measure. At a stroke, this lowered the headline inflation rate by one percentage point to 1.3% year on year, well below the 2% target. But the MPC has tightened interest rates by 50bp in response to rising house prices, planned utility price rises and...
