Experts expect sterling to remain star performer

With the prospect of a rate hike looming before the year is out, investors may want to consider where the currency is likely to go from here.

Paul Lambert, head of currency at Insight Investment, says: “The strength of the pound has been consistent with the relative strength of the UK economy and the extent to which that’s fed through to changes in the outlook for monetary policy in the UK.”

He adds: “Against the dollar… [sterling is] in line with where you would expect it to be, given what the interest rate market is expecting from both the Bank of England (BoE) and the Federal Reserve. And there’s also been some strength of the pound against the euro.”

In its latest quarterly Inflation Report the BoE lowered its wage estimate – which is likely to be a key indicator in determining when rates rise – from 2.5 per cent to 1.25 per cent for 2014.

The BoE states: “When the Bank rate begins to rise, the committee expects it will do so only gradually, and probably to a level materially below its historic average.”

For Bill O’Neill, chief investment officer of wealth management research at UBS Wealth Management, sterling has been among the strongest international currencies in the past 12 months.

He notes: “Clearly, with the sterling story, the standout issue for markets is the speed of the recovery, which is now seeing the possibility of a rate move much sooner than was envisaged six to nine months ago.”

His assumption is that when interest rates begin to rise in the UK, they will reach 1.5 per cent to 1.75 per cent by the end of 2015, meaning the pound will look attractive relative to other major currencies.

But Mr O’Neill cautions: “There is a bit of concern that external events may in some way trip up sterling’s revival, particularly given our links with the European market. We are very closely tied with the European financial money markets and if there were to be any stress or pressure on those towards the end of the year, linked to a loss of confidence in the pace of the recovery there, it would have a knock-on effect in the UK as well.”

The recent poor second-quarter data to come out of the eurozone may prompt uncertainty among investors about whether the region is on the road to recovery.

Roger Hallam, head of currency at JPMorgan, expects sterling to continue to outperform the euro over the medium term.

He continues: “The dollar is a slightly tougher call because the Fed is also slowly but surely exiting extremely easy monetary policy. Quantitative easing should come to an end in October this year and there’s a lot of debate about the timing of the first rate hike from the Fed.

“We’re also conscious that European equity markets are seeing a lot of flows into them from US-based investors. Now… if those flows were to go into reverse, that could put the euro under some pressure. With sterling highly correlated to the euro, if those equity flows started to become more dollar supportive you could see the dollar outperforming more generally.”

In spite of some near-term risks to sterling, he reiterates that in the medium term, the currency should remain relatively well supported.

Ellie Duncan is deputy features editor at Investment Adviser

Adviser view

Patrick Connolly, Chase de Vere: Independent Financial Advisers

“The strength of sterling has hit investors’ returns from overseas holdings. However, there are no guarantees that sterling’s strength will continue, especially if there is a fallback in UK economic growth and interest rates are expected to stay lower for longer. So, while we aim to manage currency risk within clients’ portfolios, we don’t make currency bets or predictions.”