Sterling rally halts around four-week high

LONDON (Reuters) - The pound flattened out on Wednesday after hitting its highest levels in almost four weeks, as speculation that the Bank of England will raise rates within the next year was cooled by broader concerns about a Brexit-driven economic slowdown.

Wads of British Pound Sterling banknotes are stacked in piles at the GSA Austria (Money Service Austria) company's headquarters in Vienna July 22, 2013. REUTERS/Leonhard Foeger/File Photo

Sterling has surged 3 percent in the past week, driven by a turnaround in the dollar and BoE minutes last week that showed a number of policymakers on the verge of voting for a rise in rates.

Another jump in inflation numbers on Tuesday pushed money markets close to fully pricing in a rise in rates within the next 12 months to prevent another dive in the currency that would raise prices of imported goods further.

But many think the bank is using hawkish rhetoric on rates to address both sterling’s weakness and rising inflation expectations at a time when measures of consumer sentiment and demand are looking shaky.

A monthly indicator run by financial data company Markit showed households at their most downbeat since 2013. The Bank of England’s regular survey of firms pointed to a greater willingness to invest but also expectations that retail sales would be weakened by higher prices.

“There are a few signs to suggest that (consumer) demand could be slowing but we haven’t seen enough yet to be sure,” said Rabobank strategist Jane Foley.

“The survey data for Feb again suggests that people are steering away from more expensive goods. I think most of the BOE are seeing it that way, but they will come out with hawkish comments mainly to control sterling.”

Several of the currency world’s top 10 banks, who were more cautious on the pound late last year, have been aggressive again in the past month in predicting more declines, pointing to the political risks of Brexit talks starting next month.

That encourages the Bank of England to defend the currency for fear of another jolt to import prices if it weakens again sharply. But any rise in interest rates would also be liable to hit household budgets given the high levels of mortgage borrowing over the past two decades.

“In general, central bankers take currency moves as an input and a bit as a given. They will tend to look through these types of factors,” said Valentijn van Nieuwenhuijzen, chief investment strategist with Dutch financial group NNIP.

“At the same time, the BOE will have been surprised by the resilience of the UK economy (last year) so there are some arguments that say that there is the risk (of a rate rise).”

The pound fell after reaching as high as $1.2507 in Asian trading. By midday in London, it was a quarter of a percent lower at $1.2444 and 0.1 percent weaker against the euro at 86.68 pence.

UK retail sales data on Thursday will be another test of whether and how quickly the economy is slowing. Dealers said sterling would struggle to pass $1.25 without another round of broader dollar weakness.

“The big near-term risk is retail sales,” said Societe Generale strategist Kit Juckes.

“If higher inflation meets softer wage growth and triggers slower consumer spending at the same time as political uncertainty increases, I can’t see anything good for sterling, valuation and positions notwithstanding.”

Editing by Richard Lough