Pound Rises to Two-Year High Versus Euro on BOE Rates Divergence

The pound rose to the strongest level in two years versus the euro amid bets the Bank of England is moving closer to increasing interest rates as its euro-area counterpart boosts stimulus.

Sterling pared a decline against the dollar after BOE Governor Mark Carney said the argument for when to raise borrowing costs “has become more balanced.” U.K. policy makers may have to move more quickly on rate increases if salary gains aren’t matched by growth in productivity, Deputy Governor Nemat Shafik told the Yorkshire Post today. U.K. government bonds climbed for a fifth day.

“Carney’s definitely preparing the ground for the first interest-rate hike,” said Jane Foley, a senior currency strategist at Rabobank International in London. “Buying the pound against the euro is a much safer proposition. There is so much dollar bullishness out there it’s more likely to be an uneven ride for cable,” she said, referring to the pound-dollar exchange rate.

The U.K. currency appreciated 0.2 percent to 78.10 pence per euro at 4:34 p.m. London time after reaching 77.85 pence, the strongest level since July 2012. Sterling fell 0.2 percent to $1.6303, having dropped about 5.2 percent since reaching this year’s high of $1.7192 on July 15.

Wage Pressure

“With many of the conditions for the economy to normalize now met, the point at which interest rates also begin to normalize is getting closer,” Carney said in a speech today in Newport, Wales. “While there is always uncertainty about the future, you can expect interest rates to begin to increase.”

The Bank of England has put wage growth at the center of the debate on when to raise rates. While inflation has dropped below the central bank’s 2 percent target, it still outpaces increases in earnings, which remain near a five-year low. Concern that pent-up pay pressure could result in a rapid surge in wages prompted policy makers Martin Weale and Ian McCafferty to argue for an earlier increase in borrowing costs.

“If those wage increases are not accompanied by productivity increases then I think we will have to move more quickly on rates because inflationary pressures will build up,” Shafik said in an interview published today. “If wage increases are expected but productivity is performing well we can wait for longer.”

The European Central Bank has stepped up efforts to boost its balance sheet amid a slowing euro-area economy. Officials have lowered interest rates, announced a program of cheap loans to banks and said the ECB would buy asset-backed securities and covered bonds.

Rates Bets

Sterling has strengthened 7.6 percent in the past year, the best performer among 10 major currencies tracked by Bloomberg Correlation-Weighted Indexes. The euro dropped 0.9 percent, while the dollar gained 6 percent.

“We expect the tightening cycle to begin in February,” said Petr Krpata, a foreign-exchange strategist at ING Groep NV in London. “This should help sterling against most of the Group-of-10 currencies. We think there is more scope for sterling gains on the euro-sterling cross as the monetary-policy divergence is crystal clear.”

The pound will be at or below 77 pence per euro in three months, Krpata said.

Forward contracts based on the sterling overnight interbank average, or Sonia, show investors pushed back bets on a 25 basis-point increase in borrowing costs to May, from February as recently as last month.

The 10-year gilt yield slid three basis points, or 0.03 percentage point, to 2.46 percent. The 2.75 percent bond due September 2024 rose 0.23, or 2.30 pounds per 1,000-pound face amount, to 102.59.

Gilts returned 7.2 percent this year through yesterday, Bloomberg World Bond Indexes show. German securities gained 6.9 percent and U.S. Treasuries earned 3.5 percent.

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