Pound sinks as strong sterling makes its mark in the markets

 

The pound sank to an eight-year low of 87p sterling yesterday, as the British currency surged to within a whisker of the three-deutschmark level.

The pound closed at 87.52p sterling, as some corporate buying dragged it off its lows in the afternoon, but analysts believe it could edge even lower, as sterling remains strong on the foreign exchange markets. "The foreign exchange market is unwilling to push the pound higher versus the deutschmark, as they fear that the revaluation issue has been far from solved," Riada Stockbrokers said in a note to clients.

"Therefore, each rise in sterling versus the deutschmark is matched by a fall in the punt versus sterling and this drags the trade-weighted punt down."

The pound closed at DM2.6126 yesterday, little changed from DM2.6114 on Monday. At these levels it reflects a larger revaluation of the pound's central rate in the ERM than many analysts are predicting, hence the general reluctance to take it any higher.

The fall in the pound, which has seen the trade-weighted index drop 0.4 per cent since Friday, is likely to raise concerns about inflation, especially as Irish interest rates will have to fall next year if they are to converge toward general European levels.

"It's something the authorities won't like to see go much further," said Mr Pat O'Sullivan, analyst at AIB Group Treasury. "We are facing what is likely to be a fairly stimulatory budget and Irish interest rates are set to fall next year. The last thing they need is for the currency to weaken sharply."

But analysts say this remains a very real prospect as the British currency, which has been supported of late by those seeking a safe haven from the turmoil in Asia, as well as an expectation that the Bank of England will tighten rates, is widely expected to make a further assault on the DM3 level.

Sterling surged to a four-month high of DM2.9980 yesterday before slipping back on profit-taking as DM3 loomed. It was also dragged lower by the dollar, following comments by Bundesbank council member, Mr Reimut Jochimsen.

Mr Jochimsen said the dollar's current strength was due primarily to turbulence in Asia but its rise would make it harder to maintain German price stability.

His comments pushed the dollar down against the deutschmark and yen.

While the long-term outlook for sterling is less than positive with most analysts expecting it to fall sharply next year, many believe it could go to DM3.02 or DM3.03 in the short-term.

This could force the pound below 87p sterling, although dealers say this is proving a solid resistance level for now, with natural corporate interest to buy between 87p and 87.25p.

The Bank of England's monetary policy committee meets today and tomorrow and few analysts expect it to raise British base rates from their current level of 7.25 per cent.

But the prospect of higher rates in the weeks ahead is likely to keep sterling well underpinned. Analysts expect British interest rates to rise by at least another 50 basis points.