Strong sterling gives power to UK investor

According to Paul Niven, Head of Strategy for F&C, this week saw two, partially related events gain material column inches in the UK's financial press. The first, the pushing through of the 3 per cent level of UK inflation which obliged Mervyn King, Governor of the Bank of England, to write his, and the Monetary Policy Committee's, first letter of explanation since independence was gained almost ten years ago. The second was sterling breaching the $2 level for the first time in fifteen years in response to the upward revision of market expectations on UK interest rates.

"Those with longer memories will recall a time when sterling traded at even richer levels versus the dollar but, in investment terms, for 25 years it has not paid to bet on further currency gains from current levels. The market has tested the psychologically important $2 level several times and each time has subsequently seen a sharp reversal of sterling strength. The question on everyone's mind is how is the currency likely react from here?" said Niven.

"Well, as previously indicated, history warns against buying sterling at current levels and our view is that sterling now appears fundamentally overvalued versus the dollar. Nonetheless, monetary policy trends are clearly dollar negative at present with a continued high likelihood of rate cuts this year while the UK will see further hikes as the year progresses. The market knows this, of course, and has already factored in such divergent moves in interest rates. In the future any sign that inflation in the UK is moderating from stubbornly high levels or signs of renewed vigour in the US economy may well force a retrenchment from stretched levels. But neither of these events looks likely in the near term. For the time being, therefore, strong sterling will continue to dampen overseas returns while increasing the buying power of the UK investor," concluded Niven.