Yields And Risk Working For The Pound Now. By Nicholas Hastings

Sterling bulls could not have asked for more.

Both yields and risk should now work in the pound's favor.

The U.K.'s surprisingly strong second quarter growth Friday removes the risk of a double dip recession and will raise expectations of a rate hike before the end of the year.

At the same time, improvements in global economic data, stronger than expected second quarter corporate earnings reports and publication of the long-awaited European bank stress tests should help to lift risk sentiment and make the pound even more attractive in the eyes of international investors.

See how the pound has already risen against the dollar:


Optimism over the U.K. economy shouldn't be overdone. The 1.1% quarter-on-quarter seen between April and June certainly won't be sustained in the second half of the year as the new coalition government's austerity package starts to bite.

A breakdown shows that the growth was spread over most sectors even though the lion's share came from services. This will certainly boost the argument for tighter monetary policy, given that most of the upward pressure on prices is coming from the service sector.

Of course, with only one of the eight-member Bank of England monetary policy committee calling of rate hike so far, chances are that a majority vote for a move is still several months down the road.

However, there is another reason why the strong second quarter growth will have a more lasting impact on the shape of the U.K. recovery and on the pound.

As Chancellor George Osborne pointed out after the figures were released, only 0.1% of the rise came from the public sector. This means that most of the increase was due to strong private sector activity that should prove more sustainable in the long run.

The likely increase in rate hike expectations, with yield spreads providing more support for the pound, should coincide with a period of higher global risk appetite.

In the last week or two, stronger economic data combined with stronger than expected corporate earnings have helped to ease fears about the global recovery.

Federal Reserve Chairman Ben Bernanke may have warned last week about the uncertainties facing the U.S. economy but he didn't suggest that the Fed was looking at any imminent monetary easing, as some commentators had feared.

Over in the euro zone, meanwhile, recent data, including forward-looking sentiment surveys, have come in better than anticipated. Hopes that this will also translate into improved growth should encourage international investors to take on more risk.

Last Friday's publication of bank stress tests in Europe will also contribute to improved sentiment, with the tests helping to remove at least some of the fears over the health of the financial system.

Only seven of the 91 banks tested were found to need additional capital. However, the credibility of the tests has been called into question and this could ensure that they act as a drag on the euro.

The pound could also find itself getting help from an unexpected quarter--the Swiss National Bank. Recent data from the central bank showed that market intervention to stop the Swiss franc from rising against the euro this year cost CHF14 billion and pushed the currency balance of its reserves out of kilter.

According to BNP Paribas, the data shows that sterling's weighting fell to 2.4% from 9.8% and the euro's rising to 70.3% from 47.4%. Correcting this could lead to some large scale purchases of the pound that could lead to a more serious fall in the euro back down towards GBP0.80.

Early Monday in Europe, the pound has risen to $1.5494 by 0645 GMT from $1.5432 late on Friday in New York, according to EBS.

The euro was up at $1.2951 from $1.2918 and at Y113.11 from Y112.98 but the dollar was down at Y87.33 from Y87.45.