Yahoo Finance 
Why the pound is soaring – and can it continue?
Since the start of the year the pound has soared to five-year highs against the dollar and retaken a chunk of its value against the euro – we take a look at what’s driving this growth and ask if it can last
There is nothing as fortuitous as a strong pound right around this time of year. Expect the beaches on the continent to be filled with Brits this summer, along with the shops of New York, as we take advantage of our mighty pound. But why is the pound so strong and will it last until holiday season reaches its climax in August?
A currency can be a reflection of an economy’s health. So the pound’s rise to a 5-year high suggests that traders have more confidence in the UK’s economic outlook than in the US’s. There is some justification to this, in the first quarter of this year; the UK’s economy expanded at a 3.1% annual rate, 30 times the size of annual growth in the US during the same time period. Even taking account of the adverse weather at the start of this year, the US’s economy is in the shadow of the UK.
Strong growth and low unemployment are sparking rumours of a potential earlier than expected rate rise from the Bank of England. While we may have to wait until the Bank of England’s Inflation Report, due on 14th May, to get clarity on the potential for future rate increases, the market is starting to believe that rate rises could be closer than the Bank is currently letting on.
The futures market, (an interest rate market that measures the probability of changes in rates), is now expecting a rate rise in the first three months of 2015, before Easter the first rate increase from the BOE was not expected until sometime after June 2015. This is significantly ahead of the US.
Rising interest rate expectations matter for a currency as this is essentially how much a currency is worth. So when UK rates are expected to be higher than its European and US counterparts this tends to fuel sterling strength.
The pound has not only rallied versus the US dollar, but the better tone to UK economic data has fuelled broad-based strength and it has registered significant gains against the Canadian dollar, the Swedish Krone and the euro since the start of this year.
Blame the Russians:
It’s not only the fundamentals of the UK economy that is spurring this strength; geopolitical issues could also be propping up sterling.
The escalation of the Russia/ Ukraine crisis has driven capital out of Russia in search of a “safe haven”. One of these havens is the UK housing market.
While wealthy Russian buyers have been a feature of the UK property market for many years, anecdotal evidence suggest that business from Russian clients has exploded in recent months. In April UK house price growth was nearly 11%, according to the Nationwide House Price survey. This is the fastest pace of growth since 2007.
To pay for UK assets, Russian buyers need pounds. While it is always difficult to pin down why a currency is rising, if wealthy Russian and Ukrainians are treating the UK as a safe haven, this could have an upward impact on sterling.
Are the Chinese to blame for a weak dollar?
Currencies are always traded in pairs, thus there are two sides to every story. Alongside the strong pound is a weak dollar story, which has helped drive pound dollar ratio to a 5-year high.
The dollar’s weakness seems to be defying logic, for example, it failed to rally even though the US created the largest number of jobs since the start of 2012 in April. Some people are blaming this on China.
It is the largest holder of US government debt in the world. It buys up US debt in an attempt to keep its currency, the Yuan, weak. Its accumulated foreign exchange reserves rose to a record high of just under $4 trillion in March. Beijing has admitted diversifying its dollar holdings, and as Europe and the UK continue to recover, they have become attractive destinations for China’s wealth as it seeks to get rid of its dollars.
Can this last?
On balance, the factors supporting the pound look fairly solid. The Organisation for Economic Cooperation and Development (OECD) has revised up the UK’s growth forecast for this year; it is now poised to be the fastest growing nation in the G7.
Thus, there could be further growth surprises in store for the UK, which could help the pound remain at these highs. Added to this, the pressure is on the Bank of England to signal when it will raise rates. If the Bank can’t raise rates when growth is this strong and unemployment continues to fall, then when can it raise rates? So the UK’s yield effect may continue to grow.
Likewise, cash flows from Russia and China could also be here to stay. Unless we see a sharp pick up in the US and a deterioration in the UK then the pound could remain the top dog in the currency world over the summer holiday season.
Right now everyone is focused on the pound reaching at $1.70, however, if the positive vibes surrounding the pound stay where they are then we could see back to $2, the 2008 dizzy heights.
Kathleen Brooks is author of Kathleen Brooks on Forex, published by Harriman House.
