For anyone betting against the pound this year could not have been more wrong. The pound rose 4 percent to $2.0403 this year to reach a 26-year high. Among disappointed investors are strategists at Deutsche Bank AG, UBS AG, and Citigroup Inc., who in December predicted the pound to trade at $1.96 or lower this year. An unexpected strong housing market and the Bank of England raising the main interest rate three times to 5.75% are the two main reasons for the increase in the pound.
The Bank of England expects the economy to expand 3 percent this year, the fastest since 2004. And with a strong economy come higher government bond yields as well. The Nationwide Building Society, the U.K.’s largest mortgage lender, reports that housing prices have increased 11.1 percent from a year ago in June. Masako Horri, at the Global Sovereign Open fund in Tokyo states the pound is a high income currency in comparison with the U.S. dollar. The U.K. economy will be spurred by housing and the consumer. Traders in the futures market have even doubled bets that the pound will continue to rise to unprecedented levels.  Â
The pound has come a long way since the English government left the European Community’s system of managed exchange rates in 1972. During this decade rampant inflation at 27 percent was the root of the prevalent economic problems throughout the country. Not until Margaret Thatcher’s rise to power in 1979 did the problems subside.
As a word of caution to investors, now may not be the best time buy U.K bonds despite signs of future gains by the pound. The reason is fear of inflation. Faster inflation may reduce the appeal of U.K. bonds and even possibly the pound. A stark increase in a currency makes investing in bonds more alluring as the return is magnified through the change in valuation. But investing in U.K. debt may be at its end as potential faster inflation looms ahead. Graeme Caughley, a fund manager at Scottish Widows Investment Partnerships Ltd., claims that inflation in the U.K. is not under control yet. On the other hand, for some analysts the high yield on U.K. debt along with a further appreciated currency is still outweighing the risks of faster inflation. The pound may still be increasing in value, but the allure of U.K. bonds may fall sooner than expected.
Posted: July 16th, 2007 under General.
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