Pound surges as traders bet on interest rate increase

The pound powered to a two-month high against the dollar on foreign exchanges yesterday after government figures showed that the pace of economic recovery is accelerating.

Sterling hit $1.6243 shortly after the Office for National Statistics said that the economy grew by 0.5% in the second quarter - a much bigger rise than the markets expected.

Profit-taking trimmed the gains to $1.6202 at close of trading in London, nearly a cent up on the previous day.

Traders are betting on an early rise in interest rates which would push up yields on sterling assets. The forward market for sterling has priced in a 75 basis point rise in rates by March 2000.

"The GDP figures today and yesterday add weight to the perception that the Bank of England has finished its interest rate cycle and this is supporting sterling," said Jane Foley, currency strategist at Barclays Capital in London.

But the rebound in sterling might persuade the Bank's monetary policy committee to hold off from raising rates. At last month's meeting the committee welcomed signs that sterling was coming off its peaks which priced British goods out of world markets, contributing to a record trade deficit in the first three months of this year.

The pace of expansion in services sector has picked up, the ONS said yesterday. It grew by 0.5% in the second quarter, after recording 0.4% growth in the first three months of the year.

The ONS said Britain's manufacturing sector has finally clambered out of recession. After three quarters of contraction, it showed a "slight increase" in output in the second quarter, according to an ONS statistician.

He added that most sectors within manufacturing showed increases but that the recovery was not universal.

A more detailed picture of the sector will emerge next week when business surveys are expected to show renewed growth in July.