Sterling rebounds on rising inflation risk

Sterling's post-election rally maintained momentum on Monday, approaching an 11-week high against the dollar as sentiment focused on the strength of the British economy and the outlook for interest rate policy.

The pound hit $1.5523, its highest level since February 26, after the Bank of England's Monetary Policy Committee meeting, held over from last Thursday's general election, as traders anticipate stronger warnings about investor complacency over inflation.

Marc Chandler, strategist at Brown Brothers Harriman, said the bank has previously ''warned that the pass through from sterling's depreciation could be quicker than in the past''.

Earlier on Monday, the pound dipped below $1.54 on market worries about the UK's role in Europe weighed on gains after the Conservatives' surprisingly strong election victory last week.

Currency traders were expecting a shortlived post-election rally for sterling as they train their sights on the prospect of Britain leaving the EU in a referendum promised by David Cameron, the prime minister. But selling was shortlived on Monday and the currency also gained 1 per cent on the euro, as eurozone finance ministers' talks with Greece caught traders' attention.

The BoE as expected, kept official borrowing rates at 0.5 per cent, and attention shifted to the Bank's quarterly inflation report due on Wednesday after the release of data on industrial output and the labour market.

Alvin Tan, currency strategist at Societe Generale, said he expected sterling to be boosted by a dip in the jobless rate and more hawkish noises in the BoE inflation report on the back of rising oil prices and the UK's economic recovery.

The euro's rally against the pound had now turned down sharply. "We see the longer-term downtrend reasserting itself," he said.

Market expectations for inflation over the next decade climbed to their highest level since December on Monday, and at 2.75 per cent have risen from January's low of 2.28 per cent.

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Sterling bulls would be "rubbing their hands with excitement" at a possible MPC split, said Mr Lydall, adding that a pick-up in UK growth and inflation above 1 per cent in the coming months would bring forward expectations of an interest rate rise.

Since election day sterling has rallied 2 per cent on the dollar.

But Steven Barrow, G10 currency strategist at Standard Bank, said there is a limit to post-election optimism, and that "this might be as good as it gets for the pound".

For one thing, he said, a "Brexit" referendum could still be a close call despite the Conservative opposition to leaving the EU. Another bout of austerity could cause the economy to turn down, which would be "anything but positive for the pound", Mr Barrow added.

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