LONDON (Reuters) - Sterling hit a four-week high against the euro on Monday, bolstered by the view that the Bank of England will raise interest rates for the first time in over a decade this week.
The pound has seesawed in recent weeks, sensitive to reports of a lack of unity in the Conservative government as well as to signs that Britain might not secure a strong enough Brexit deal, but kept afloat by the expectation that the BoE is on course to hike interest rates.
The market is now largely priced in for a 25-basis-point rise on Thursday.
The move will reverse a rate cut following Britain’s vote last year to leave the EU.
A Reuters poll of economists found the majority expected the central bank to lift the cost of borrowing to 0.5 percent after its next meeting on Nov. 2.
“It will be a major, major surprise if the Bank didn’t hike interest rates on Thursday,” said ING’s currency strategist Viraj Patel.
“It would certainly be catastrophic for sterling, because speculation of that rate hike has provided a floor for sterling and stopped it from sliding lower ... You take away that support and it’s like pulling the rug out from under sterling’s feet,” he added.
This renewed confidence boosted the pound to its highest against the euro since Sept. 29, at 87.93 pence per euro. By 1652 GMT it had eased slightly to 88.11 pence, still up 0.3 percent on the day EURGBP=D3.
Sterling also strengthened against the dollar, rising 0.7 percent on the day to $1.3213 and making a significant recovery from a three-week low of $1.3070 hit on Friday GBP=D3.
However, analysts are doubtful that the British economic landscape offers scope for a longer-term tightening cycle even if Thursday’s rate hike goes through.
UBS currency strategists wrote in a note to clients on Monday that sterling was “torn between two forces”.
“We see tighter Bank of England monetary policy on the one hand, counterbalanced by uncertainty surrounding Brexit talks on the other,” they wrote.
“The former should lead to higher UK yields, underpinning sterling, while the latter may weaken the pound, dragging (it) down to $1.20 should talks collapse,” they continued, adding that they expected sterling to strengthen to around $1.36 on the back of tighter BoE policy.
Britain’s quarterly growth, at 0.4 percent, would also offer the weakest backdrop to any rate rise since the BoE became independent in 1997.
Graphic: sterling and gilt yields bit.ly/2dgAXn1
Graphic: World FX rates in 2017 tmsnrt.rs/2egbfVh
Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv
Reporting by Polina Ivanova; Editing by Jemima Kelly and Alison Williams