Sterling firms as focus turns to UK fundamentals, rate outlook

2014-10-13

(Reuters) - Sterling rose on Monday, inching back towards recent two-year highs against the euro and moving higher against the dollar as investors focused on Britain's economic fundamentals and interest rate expectations after Scotland's independence vote.

The euro traded 0.2 percent lower against sterling at 78.64 pence, not far off a two-year low of 78.10 struck on Friday amid relief over the Scots' decision in a referendum to reject independence and to stay inside the United Kingdom.

The pound rose 0.35 percent against the dollar to trade at $1.6340, with the greenback coming under some pressure after it posted its 10th straight week of gains on Friday.

"We continue to see further upside to sterling this week as the currency should now return back to fundamental drivers, with the UK data obtaining more prominence again," said Petr Krpata, currency strategist at ING.

"We still think that the pound has to do some more catching up following last week's back-to-normal correction in short-end UK yields."

He added that the UK two-year bond yield was not far from its July highs and a break above that levels would take it to its highest in over three years, giving sterling a boost.

With the uncertainty over the Scottish referendum out of the way, investors judged that one more obstacle to an interest rate hike from the Bank of England was cleared for the time being.

Sterling overnight interbank average rates are pricing in the chance of a first rate increase by the BoE in the spring of 2015. Analysts said sterling stood to gain more against the euro and yen since both the European Central Bank and the Bank of Japanare likely to stick with an ultra-loose monetary policy.

The U.S. Federal Reserve reiterated last week that, while near zero rates would be maintained for a considerable time, rate hikes could come at a faster rate next year and in 2016. The Fed nudged up its expected path of interest rate increases - or Fed dots - boosting yields on U.S. notes, and hence the appeal of the dollar.

And although the dollar gave back some of its gains on Monday, traders said the pound's rebound against the greenback would be capped. They said uncertainty over future constitutional changes in the United Kingdom following the Scottish referendum could weigh on investment flows.

"We expect sterling/dollar rebounds to remain limited, keeping the downtrend intact," Morgan Stanley said in a note.

"Political uncertainty is set to remain as the general election approaches next year and there is a constitutional debate regarding providing more powers to Scotland in combination with changes to English MPs only voting on English issues," Morgan Stanley said in a note.