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Sterling rides high on big spending

A high-spending chancellor and a continuing consumer boom might not be in the long-term interests of the UK. They are, though, fundamental to foreign investment that is pushing up sterling.

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 private credit growth.

So far, the Bank of England?s warnings have been ignored. Consumer credit rebounded in January as borrowers increased credit card spending by £1.9 billion ? the biggest monthly rise since last May. And banks and building societies continue to throw credit at prospective house buyers. Expect Bank governor Mervyn King and the MPC to keep up the pressure.

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