British pound breaks $2 barrier

The last time the currency traded above $2 – on September 16, 1992 – the elder George Bush was waging a losing US presidential campaign against Bill Clinton and the Eurotunnel linking the UK to Europe was still under construction.

This period marked the end of Britain‘s membership to the European Exchange Rate mechanism, which pegged the pound to the currencies of other EU members.

 

Almost 15 years later, an unexpected surge in inflation led economists to conclude that multiple interest-rate increases were likely, and the pound touched the $2 mark.

 

The prospect of higher rates can boost a currency by promising bigger returns on certain investments denominated in it.

 

Psychological notch

 

While the currency has been flirting with the $2 level for several months, hitting it marks a key psychological notch in trading that analysts expect to hold.

 

The pound reached a high of $2.0074 before dropping back to $2.0066 in late New York trading, up from $1.9900 on Monday.

 

“Obviously it causes difficulties for manufacturers and exports, and on the other hand it also provides a countervailing pressure on inflation” Tony Blair, UK prime minster

Tourism operators expect the new round figure to jog interest in bookings to the United States, with shopping breaks in New York proving popular the last time the pound threatened $2 in November.

 

Conversely, Britain will become more expensive for US tourists – but economists noted that the euro has also become stronger against the dollar and local travel agencies do not expect to see a large drop in visitors given that the currency has been hovering near $2 for several months.

 

Euro gains

 

The Euro also rose against the dollar this week and raced past US$1.36 for the first time since December 2004 in early trading on Wednesday.

 

Ryohei Muramatsu, Commerz Bank treasurer, said: “The difference between the economic performances of Europe and the US is driving currency trading.”

 

“Investors are taking advantage of widening interest rate differentials. While data on the US economy is patchy the strength of the European economies stands out,” he added.

 

Tony Blair, the UK prime minister, was optimistic about the pound’s new level, pointing out that while it makes exports more expensive on international markets, it also helps keep a lid on inflation.

 

“Obviously it causes difficulties for manufacturers and exports, and on the other hand it also provides a countervailing pressure on inflation … but that is something … the market will decide,” he said.

 

Sterling strength

 

The currency spiked after the government’s Office for National Statistics revealed that consumer price inflation accelerated to 3.1 per cent in March, up from 2.8 per cent in February.

 

More than one per cent above the government’s two per cent target, the increase triggered Mervyn King, the Bank of England governor, to write a letter of explanation to Gordon Brown, the Chancellor of the Exchequer, for the first time since the bank was given its independence in May 1997.

 

King said in the letter that the faster inflation reflected an “unexpectedly sharp” increase in domestic energy prices during the second half of last year and higher food prices, caused by a weather-induced global reduction in supply.

 

Inflation was also supported by increased spending and business confidence, he said.

 

Britain’s economy has been expanding despite three interest-rate increases since August and Brown, who took over the financial reins when the Labour Party came to power in 1997, has been lauded for producing a record growth cycle.

 

Philip Shaw, chief economist at Investec Securities, said the inflation figures made an interest-rate increase “a certainty, along with the possibility of another rate rise beyond that”.