Pound struggles for parity as sterling surges

STERLING has surged again on international currency markets, driven higher by speculation of further increases in British interest rates. The length of sterling meant the pound dipped below parity on a number of occasions before closing at 100.02p.

The Central Bank has actively supported the pound when it has dipped below sterling in recent days, although dealers could not confirm whether there was intervention yesterday. The pound dipped to just below 99.8p sterling at one stage.

Sterling was boosted by figures showing an acceleration in the underlying annual rate of British inflation to above 3 per cent last month, the largest one month increase in the last four years. It climbed by 1.92 pfennigs to 2.5109 deutschmarks, around 9 per cent higher than three months ago and the highest rate since early 1994.

Dealers in Dublin said sterling was likely to remain strong and was set to rise further. This will not be welcomed by the Central Bank, which wants to maintain a firm exchange rate against sterling to combat inflation.

The pound followed sterling up against the deutschmark, rising to DM2.51 from DM2.49. Dealers said the strength of the pound against currencies such as the deutschmark and the dollar was leading to some selling of the pound in return for these currencies. However, there was also some demand to buy the pound when it dipped below parity against sterling.

As sterling powered ahead, the British currency's trade weighted index, measuring the value of the currency against a basket of worlds currencies rose 0.6 to 91.9, a level - not seen since shortly after sterling - was ejected from the Exchange Rate - Mechanism in 1992.

The "headline" rate of annual - British Retail Price Index inflation jumped 0.6 percentage points to 2.7 per cent and the underlying inflation rate, which excludes mortgage interest payments, rose 0.4 per cent to 3.3 per cent. MostCity attention focused on the rise in underlying inflation, which is now well above the government's target level of 2.5 per cent or under by the end of next year.

Blame for the revival of inflationary pressures is mainly put on higher housing and motoring costs. But the seasonal decline in food costs has also been less than usual this autumn, reflecting the concerted drive by supermarkets to restore profit margins. The worsening inflation figures immediately fuelled City of London speculation that the Chancellor of the Exchequer, Mr Kenneth Clarke, may be forced to sanction another increase in British interest rates before the year's end.

Two weeks ago, Mr Clarke surprised the financial markets with a 0.25 per cent rise to 6 per cent, saying the increase was intended to "nip inflation in the bud". Treasury briefings then suggested the rise would preclude the need for a rate in the run up to the general election next spring and, as such, as seen as a politically astute move to take the pain of higher money costs well before the election campaign gets under way.

Now however, a different interpretation is being put on the 0.25 per cent increase. Notes of meetings between Mr Clarke and Bank of England governor Mr Eddie George indicate the Bank had been pressing for a larger rise of 0.5 per cent. Sterling's surge yesterday reflected the gathering conviction that the Bank will get its way, possibly as part of a "responsible" budget to be unwrapped by Mr Clarke in two weeks time.

Adding to the upward pressure on sterling at a time of low interest rates in Europe was an increase in forward money market rates. They rose seeking to discount further hikes in British interest rates towards 7 per cent after the general election. While sterling is now being priced on the expectation of higher interest rates, economists are greatly divided on the durability of sterling's unexpected revival in recent weeks.