Pound strengthens to 4-month high against the US dollar

The pound strengthened against the US dollar yesterday, hitting a four-month high as the bull-run on the FTSE 100 continued and risk-appetite improved strongly. The FTSE 100 finished up 93.7 points yesterday at 4336.9 as rising oil prices and concerns over the threat of swine flu eased. Banks in particular performed strongly yesterday, as the index notched up its best month in six years in April. Although there was some wariness in the market ahead of the results of US government “stress tests” on major American banks, carry trade activity also increased yesterday morning as investors sold off perceived low-yield dollar assets to purchase higher-yielding sterling stock. The pound broke through the psychological $1.50 level mid-morning, briefly touching the $1.51 level, although investor caution over the Bank of England’s policy meeting later this week capped its gains. Most analysts fully expect UK interest rates to remain on hold at 0.5%, but the market remains nervous about whether the central bank plans to extend its quantitative easing program beyond the current £75 billion. Sterling’s gains were also capped to some extent yesterday morning as investors continued to digest the European Commission’s revised growth forecasts released on Monday. It predicted the UK economy would shrink by 3.8% this year and grow 0.1% in 2010, two figures at odds with Chancellor Alistair Darling’s forecasts outlined in his budget two weeks ago.

The pound’s gains against the dollar were extended yesterday afternoon after a better-than-expected services industries report released in the US further improved investor risk appetite. The Institute for Supply Management index for April came in at 43.7, a marked improvement on the 40.8 figure for March. Although this still represents a contraction, it is the slowest contraction in the sector for six months, further fuelling hopes that a recovery may soon be underway. Elsewhere, Fed Chairman Ben Bernanke’s evidence before a congressional Joint Economic Committee provided investors with an insight into the central bank’s thinking going forward. He echoed last week’s Fed interest rate announcement that the bank has no intention of halting its quantitative easing program at the moment. This news further encouraged investors to sell dollars and buy into the “riskier” pound as they concluded the Fed’s measures must therefore be working and a global economic recovery may not be too far off. However, the pound did retract slightly from its peak late yesterday afternoon as traders became more cautious ahead of tomorrow’s Bank of England meeting and release of the US bank “stress test” results. Nevertheless, sterling finished the day up at $1.5084.

In early trading today, the pound has pared some of its gains against the dollar as investors become increasingly nervous about tomorrow’s two major announcements. There are no major data releases in the UK today, while in the US the ADP Employment Change figures for April are due at 13.15 BST.