CURRENCIES

THE POUND may decline against the dollar on expectations that the US Federal Reserve will raise its benchmark lending rates - so boosting the return on US currency deposits.

A 25 basis-point rate rise by the Fed would bring benchmark interest rates in the US and UK to the same level for the first time since late 1987, when the US started using its rate as a short-term lending target.

That means investors looking for the highest yields are likely to shun pounds and favour dollars.

"Weaker pound levels versus the dollar are likely as the UK-US rate spread vanishes," though there will be no "sterling crisis", said Chris Iggo, chief international economist at Barclays Capital.

On Friday the pound was at $1.5906, down more than 4 per cent this year. The pound is poised to decline against the euro, meantime, amid signs European economies are rebounding.

It fell on Friday, letting the common currency rise to pounds 0.6580, as a report showed an unexpected surge in French consumer spending. The euro also rose against the dollar to as high as $1.0481, its highest level since 14 June when it was at $1.0515.

Expectations for higher Fed rates have erased the premium UK deposits have had over dollar deposits for much of the past decade. Three-month dollar lending yields 13 basis points more than three-month sterling lending, compared with the 100 basis-point premium UK money market accounts offered in January.

Much of the pound's direction this week is likely to be determined by the Fed's policy makers' meeting in Washington on Wednesday: they are expected to raise their rate for overnight lending between banks by 25 basis points, to 5.0 per cent. Some investors see it rising 50 basis points.

"We will see a 25 basis-point rise in the US next week and there's an outside chance of a 50 basis-point rise," said Marc Dodd, associate director at Tilney Fund Management.

Still, the pound won't lose too much ground against the dollar as signs of a reviving economy lessen the scope for more UK rate cuts. Figures on Friday confirmed that the economy didn't slip into recession in the first quarter.

A survey by the CBI showed that manufacturers see their prospects improving in the coming months. For the first time this year, the group also refrained from asking the Bank of England to cut rates, which can compensate for the pound's effects on exports by lowering the cost of borrowing.

"If we're near the bottom of the cycle in terms of rate cuts, then sterling can strengthen," said Simon Lue-Fong, who helps manage $15bn in fixed income at Fischer Francis Trees & Watts. "The UK is still a great place in terms of [its economic climate]," he said.

The yield on interest rate futures contracts expiring in September is at 5.08 per cent. That's close enough to 5.16 per cent, the yield on current three-month lending, to suggest few investors see lower rates before the end of September.

The pound can also get support against the dollar if a larger than expected US rate rise hurts US bonds and stocks, sapping investors' demand for the currency needed to pay for the assets.