Stronger pound could hit recovery

20 dollars and 10 poundsThe pound has defied recent expectations of a fall as it heads towards a level of 1.60 US dollars for the first time in eight months.

A focus on prospects for a tapering of monetary stimulus in the American economy has pushed down the greenback against sterling in the money markets.

Investors believe the withdrawal of former Treasury Secretary Larry Summers from the running to become the next chair of the US Federal Reserve makes a sharp cut in the Fed's multi-billion dollar quantitative easing (QE) programme less likely.

It comes on top of a recent improvement in the pound's fortunes due to scepticism over Bank of England governor Mark Carney's flagship low interest rate policy.

The strengthening in the currency may have come too late for many British summer holidaymakers but could make imported goods and materials cheaper for UK firms and consumers.

By contrast, exporters are likely to face a struggle to sell their products abroad as they become increasingly expensive - threatening prospects for recovery in the country's beleaguered manufacturing base.

The pound has been rising since plunging to below 1.49 US dollars in July, and pushed above 1.59 following the latest announcement about the future running of the Fed.

But the strength of sterling could hamper the UK's efforts to boost gross domestic product, which remains 3% below pre-recession levels.

Lee Hopley, chief economist at manufacturers' organisation EEF, said: "The higher pound is going to be an issue for some exporters.

"A lot of what British companies export is less price sensitive than it used to be, but it will still be an issue. Quite a bit of the recovery has been led by exports."

Sterling has been on a rollercoaster ride over the summer, falling sharply on the initial impact of Mr Carney's arrival at Threadneedle Street, after an indication that interest rates would remain low for some time to come.

The prospect of cheap money pushed stock markets up but sent the pound spiralling lower, with some analysts predicting it would go as low as 1.30 US dollars, given the decline in North Sea oil production and continued trade deficit.

However, sentiment hardened as doubts began to emerge about the details of the Bank's "forward guidance" policy, linking any possibility of an interest rate rise to a fall in unemployment to 7%.

While the headline guidance suggested this meant they would not rise until 2016 at the earliest, traders began to believe the Bank's forecasts on unemployment were too pessimistic, leading to the expectation that rates would come up sooner.

The likelihood of higher interest rates has led traders to expect there will be increasing demand for the pound, pushing up its price.

In addition, this weekend's announcement by Mr Summers that he was pulling out of the race to lead the Fed has depressed the dollar

Mr Summers was seen as a sceptic on the Fed's QE policy. The prospect of billions continuing to flow out of the central bank continuing to flow into the US economy unhindered drove down the value of the currency.

Some economists already believe the rise in the sterling has gone too far, however, and that it is set for a fall.

Jessica Hinds of Capital Economics said that the rise in the pound was already looking overdone last week, predicting that UK rates were likely to remain at their current low until 2017 amid a recovery not yet as strong as that of the US.