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To infinity and beyond

18 June 2014 By Swaha Pattanaik

Sterling has touched $1.70 and is on the brink of bursting ranges which have confined it for five years. Could a resurgent pound return to pre-crisis levels of $2?

After such a runup, this sounds like fantasy. But a few shifts could make it more realistic. First, inflation would need to quicken. Higher productivity and employment would need to fuel pay rises, in turn permitting price hikes from retailers. Second, frothy house prices would have to prove resistant to anything other than blunt rate rises.

In sterling bulls’ ideal world, this combination would force the Bank of England to raise rates even more quickly than Governor Mark Carney has flagged, and not just once.

Investors still trust the central bank when it says rates will rise slowly. Any sign this gradualism is over would turbo-charge sterling’s rally. Gains would be even greater against the dollar if the Federal Reserve kept U.S. rates near zero for longer than markets expect – as the International Monetary Fund predicted on Monday.

This would still leave some hurdles in the way of a move to $2. Scotland rejecting independence in a referendum on Sept. 18 would remove one. Reducing Britain’s budget shortfall would help, not least because it would make gilts more attractive.

A narrower current account deficit would also help. That would provide support for sterling and act as less of a drag on growth. In turn, the BoE would find it easier to tolerate a strong currency. Don’t hold your breath, though: previous attempts to boost British exports have flopped, even when sterling was much lower.

Sterling at $2 seems a stretch of the imagination. If a few things fall into place, it might start to look more feasible.


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