CURRENCIES

THE POUND is expected to keep the past week's 2.5 per cent gain against the dollar on optimism that evidence of faster UK economic growth will persuade the Bank of England to leave interest rates on hold this week.

Reports in recent days showed the economy grew more than the Government previously forecast in the first three months of the year, while in the second quarter growth was quicker than expected.

More evidence will come before the Bank of England starts its two-day meeting on Wednesday as the Chartered Institute of Purchasing and Supply releases its surveys on manufacturing and services industry in July. Its June index showed manufacturing activity expanded for the first time since March last year.

"The Bank of England appears to be done cutting interest rates, and we're starting to see a turn-around in GDP figures," said Jeff Woodruff, a currency strategist at Bank Boston. "If we begin to see [more] positive economic data, sterling could [hold last week's four-cent gain]", he said.

On Friday, the pound climbed to a two-month high of $1.6244 from $1.6183 late on Thursday after the Government said the economy grew at a faster than expected 0.5 per cent pace in the second quarter. The pound gained 3 per cent against the dollar in July.

Sterling rose to 0.6585 per euro from 0.6627 late on Thursday. It has climbed about 1 per cent against the euro in the past week. "We're pretty positive on sterling, longer term," said David Doyle, head of foreign exchange at Banca Popolare di Milano.

Signs of rebounding growth mean the Bank of England may even raise interest rates before the end of the year. The prospect of higher rates boosts the pound because it means a better return on sterling deposits. Three- month pound deposits now pay 5.27 per cent, seven basis points lower than those denominated in dollars and about 260 basis points more than euro deposits.

"There are lots of reasons to be optimistic [about growth]," said Ciaran Barr, an economist at Deutsche Bank. He has raised his forecast for economic growth to about 1.5 per cent for this year and between 2.8 per cent and 3 per cent next year. The benchmark interest rate, now at 5 per cent, "will rise to at least 6 per cent next year".

Rates on sterling interest rate futures soared in July. The rate on the March contract rose about 40 basis points for the month and at 5.94 per cent is far enough above current three-month lending rates of 5.27 per cent to suggest traders and investors expect borrowing costs to rise at least half a percentage point by March.

Bank of England policymakers have slashed the benchmark repurchase rate 2.5 percentage points in the past 10 months in an effort to keep the economy growing. They left the rate at 5 per cent, a 22-year low, earlier this month.

Some investors said that they doubted the Bank of England would raise interest rates this year because there is scant evidence that faster growth is pushing up inflation.

"Inflation is benign," said Marc Dodd, associate director at Tilney Fund Management.

"I don't think we'll see a rate hike in the next six to nine months."