CURRENCIES

THE POUND, up 1 per cent against the dollar last week, may extend its gains on the speculation that improved UK growth will prompt the Bank of England to start raising interest rates by the year-end.

"There is a reasonable chance the pound could be one of the strongest currencies of the year," said Peter Lucas, global investment strategist at Ashburton (Jersey). "The economy has turned the corner. The chances are interest rates could start to creep up by the end of the year."

On Friday, the pound was little changed at 0.6653 per euro from 0.6670 late on Thursday. That's the equivalent of DM2.94. It slipped to $1.5774 from $1.5844 on Thursday, up about three cents from a 35-month low of $1.5483 on 12 July.

Hopes for quicker economic growth were boosted by a report on Friday showing that the UK's trade deficit shrank more than expected in May. The Office for National Statistics said the deterioration in the trade balance in the last year might now be "levelling off". More details on the state of the economy will come on Tuesday as the Confederation of British Industry releases its industrial trends survey for July.

On Friday, the Government releases its first estimate of economic growth in the second quarter of this year. Economists expect the economy to have grown 0.4 per cent in the quarter and 0.8 per cent from a year earlier.

Recent surveys have shown business confidence and manufacturing and service industry improving in the second quarter. In addition, the records of the Bank of England's 7-8 July monetary policy meeting showed that policy makers didn't discuss cutting the benchmark rate - already at a 22-year low of 5 per cent - any further.

Suzanne Hudson, international economist at American Express Asset Management, said: "It's highly unlikely they'll cut rates again."

Rates on sterling interest rate contracts that mature in December anticipate money-market rates of 5.54 per cent, 36 basis points higher than current three-month lending rates and high enough to reflect expectations for a quarter-point rate increase before the year-end. Higher returns on sterling deposits make the pound more attractive.

In New York, the dollar fell against the yen, approaching a five-month low, as investors pour money in Japanese equities. The dollar may drop further this week, though the loss will be limited on speculation the Bank of Japan will sell yen again.

"Into this week selling pressure is likely to remain [and weaken the dollar]," said Bob Lynch, currency strategist at Paribas. The dollar would probably fall "unless the Bank of Japan takes on a more active role again".

The dollar fell 3.6 per cent last week, falling to Y116.15 at one point, the lowest since February. Against the euro, the dollar fell 2.7 per cent last week, leaving it up 11 per cent since the single currency launched in January. The euro advanced on optimism that European economies are reviving and the currency has risen 3.3 per cent since it sank to its lowest level of $1.0108 on 13 July.

"The underlying trend is still positive [for the euro]," said Ian Morris, an economist at HSBC Markets. "It is still undervalued and should appreciate in the coming months."