June 16 (Bloomberg) -- The pound reached the strongest level in 20 months versus the euro as speculation the Bank of England is moving closer to raising interest rates boosted the allure of U.K. assets.
Sterling traded above $1.70 for the first time since 2009 after Bank of England Deputy Governor Charlie Bean said higher rates would be a sign that the economy was returning to normal. The currency posted its biggest weekly gain in four months after BOE Governor Mark Carney said on June 12 that borrowing costs may rise sooner than economists expect. Two-year government bonds fell, reducing the yield difference with 10-year gilts to the least in almost a year.
“We continue to be constructive on sterling, especially against the euro, where the monetary policy cycles are continuing to diverge,” said Josh O’Byrne, a foreign-exchange strategist at Citigroup Inc. in London. “Carney was more hawkish than expected and you saw an upward revision in rates markets. This morning we’ve seen rates tick up further still and the pound generally supported.”
Policy makers are due to release the minutes of their June 4-5 meeting on June 18 as money-market rates indicate the Bank of England will raise rates as soon as February. In August 2009, when Britain’s currency fell below $1.70, the central bank was expanding its balance sheet by buying government bonds in an attempt to revive the economy from the worst recession since World War II.
Sterling was little changed at 79.89 pence per euro at 4:11 p.m. London time after advancing 1.9 percent over the past eight days. It earlier appreciated to 79.59 pence, the strongest since Oct. 1, 2012. The pound was at $1.6985 after rising to $1.7011, the highest since Aug. 6, 2009. It climbed 1 percent last week, the most since the period ended Feb. 14.
Citigroup forecasts the pound will advance 0.8 percent to $1.71 by year-end, stronger than the $1.65 median of analyst estimates compiled by Bloomberg. The bank is the biggest foreign-exchange trader, based on a Euromoney Institutional Investor Plc survey published last month.
The pound strengthened 9.2 percent in the past year, the best performer among 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes, as a strengthening U.K. economy boosted speculation the Bank of England will move closer to raising interest rates. The euro gained 1.9 percent and the dollar advanced 0.1 percent.
An increase in interest rates “will be a symbolic step, because it will be an indication that we are on the road back to normality,” Bean, who oversees monetary policy at the central bank and will retire on June 30, told the Sunday Times in an interview. “I would welcome us getting on to the path of normalization, as a demonstration that the economy is healing,” he added.
Credit Suisse Group AG and Commerzbank AG brought forward their predictions of when the Bank of England will first raise its key rate to November. Credit Suisse analysts had previously forecast an increase in February 2015, while Commerzbank predicted policy makers would act in the summer of 2015.
Forward contracts based on the sterling overnight interbank average, or Sonia, show investors are betting the benchmark rate will increase 25 basis points, or 0.25 percentage point, by February, versus May before Carney’s speech last week.
The Bank of England’s main interest rate has been at a record-low 0.5 percent since March 2009.
“The market is coming around to the idea that the U.K. may become the first major economy to raise interest rates,” said Neil Jones, head of hedge-fund sales at Mizuho Bank Ltd. in London. “The interest-rate differential is causing the pound to perform well against pretty much every other currency, and one can understand why.”
Sterling could strengthen to 75 pence per euro in the next nine months, Mizuho’s Jones said.
The prospect of higher rates is prompting investors to sell shorter-dated government debt securities, resulting in a flattening of the yield curve, which is a chart showing rates on bonds of different maturities.
The extra yield that investors get for holding 10-year gilts instead of two-year securities narrowed three basis points to 185 basis points and reached 184 basis points, the tightest since June 21, 2013.
Two-year yields climbed four basis points to 0.90 percent, the highest since June 2011. The 2 percent gilt due in January 2016 fell 0.065, or 65 pence per 1,000-pound face amount, to 101.745. The 10-year yield increased one basis point to 2.75 percent.
The divergence in yield movements shows that investors are selling securities with shorter maturities, which are more sensitive to the outlook for monetary policy. Longer-dated bonds react more to investor expectations for inflation.
Carney is also preparing to lead a discussion among Bank of England financial-stability officials tomorrow on whether action is needed to prevent the property market from overheating. A Rightmove Plc report today showed asking prices for London homes slipped from a record this month, the first decline this year.
The governor may have caused financial markets to react excessively, a former Bank of England policy maker said.
“I think the markets are overreacting,” Adam Posen, president of the Washington-based Peterson Institute for International Economics Inc, said in an interview with Bloomberg Television’s Guy Johnson and Olivia Sterns in London today. “I think he got the calibration wrong and didn’t fully price how big it was going to be.”
Gilts returned 2.9 percent this year through June 13, according to Bloomberg World Bond Indexes. Treasuries earned 2.8 percent and German securities gained 4.1 percent.
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