The pound has topped $1.34 against the dollar for the first time in a year, emboldened by a strong hint from the Bank of England that it will raise interest rates sooner than previously expected, but the rally could prove short-lived.
On Friday morning, sterling was trading at $1.344, its highest level since September last year, and around €1.126 against the euro. The Bank of England on Thursday published its latest decision on interest rates. Although the committee—like last month— voted 7-2 against an immediate move higher, sterling shot up as the minutes from the meeting showed that the Bank was preparing for its first move higher in over a decade in the “coming months”.
Higher interest rates generally tend to support currencies.
Over the longer term, however, many strategists still think that the pound will struggle to sustain its upward trajectory as a result of ongoing uncertainty around Brexit.
Economist at UniCredit wrote in a note on Friday that they have a “short-term upside bias for sterling” against the US dollar and – – to a lesser extent – against the euro.
“Our long-term view, however, remains bearish,” they said.
“First, despite the increasing odds of a BoE rate hike, we think the BoE would make a policy mistake by hiking in the current uncertain environment. If the BoE recognises this and leaves interest rates at current levels, this would lead to a reversal of the recent rally in [sterling],” they wrote.
“Second, even if the BoE tightens monetary policy, this does not justify any sustainable sterling appreciation, in our view. Most of the weakening of sterling since the referendum result has been due to the significant risks related to Brexit. This risk premium is irrespective of the level of rates,” they added.
Strategists at Societe Generale agreed.
“Sterling has rallied strongly in recent weeks, as the market prices in a BoE rate hike in the first quarter of 2018,” they wrote in a research note. “But it is not sustainable in our view.”
