U.K. Pound Rises to 26-Year High Against Dollar on Rate Outlook

By Kim-Mai Cutler

Bloomberg -- The pound rose to a 26-year high against the dollar on speculation the Bank of England will keep interest rates at a six-year high while the Federal Reserve cuts borrowing costs tomorrow.

U.K. central bank policy maker Kate Barker signaled the rate-setting committee isn't yet convinced that signs of a slowdown in Europe's second-biggest economy warrant a cut in the benchmark interest rate. Interest-rate futures imply 98 percent odds the Fed will reduce borrowing costs tomorrow.

``The market mindset is that the Fed will continue to cut rates, while in the euro zone and the U.K. there's no certainty in that respect,'' said Neil Mellor, a currency strategist at Bank of New York Mellon Corp. in London. ``All roads point south for the dollar.''

The currency advanced to $2.0656 against the dollar as of 12:16 p.m. after trading at $2.0663, the highest since May 29, 1981. Analysts forecast the pound to trade at $2.03 by the end of the year, compared with the $2.06 predicted by the forwards market.

While the U.S. economy is grappling with its worst housing slump in 16 years, the U.K. economy grew faster than economists forecast in the third quarter, the government said on Oct. 19. Gross domestic product increased 0.8 percent, led by services from airlines to banks.

The Bank of England has raised interest rates four times in the past year to a six-year high of 5.75 percent in July. Policy makers considered a cut this month and then voted 8-1 for no change, with only David Blanchflower in favor of a reduction to counter a jump in corporate credit costs after contagion from the U.S. subprime mortgage-market collapse.

No Change

Economists predict the rate will be unchanged on Nov. 8, the median of 37 forecasts in a Bloomberg News survey shows.

``We are asking ourselves if things are so different from August, and do we actually have to cut rates?'' Barker said in comments to the Guernsey Press and Star newspaper, which were confirmed by the central bank. She said the economy is in a slowdown rather than anything more serious, the newspaper reported.

With the bank's rate increases, the pound has strengthened 8.6 percent over the last year against the dollar.

The Fed has cut rates once this year as the housing slowdown and credit-market turmoil threatened economic growth. The bank may lower its target rate for overnight loans between banks by 25 basis points again tomorrow, to 4.5 percent, futures trading shows.

U.K. government bonds fell, with the yield on the 10-year gilt up 2 basis points to 4.87 percent.

To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net