Strengthening pound hits 26-year high against dollar

The pound reached a 26-year high against the US dollar, closing at $2.0683 after earlier nudging past $2.07.

After a few weeks of relative weakness, sterling is back to the levels seen earlier this summer, comfortably over the $2 mark, with the euro recently also hitting "career highs" against the greenback.

Short term, the markets are very much influenced by the upcoming decisions on interest rates to be made by the US Federal Reserve and the Bank of England. The Fed is widely expected today to announce a cut in its main interest rate, as the American central bank continues to support a financial system still in the grip of the credit crunch and a worryingly weak economy.

Many investors and economists predict the Fed will follow up its half percentage-point rate cut in September with another, probably smaller, reduction when they wrap up their meeting. The federal funds rate will probably will be lowered by a quarter percentage point to 4.5 per cent, most analysts predict.

The federal funds rate is the Fed's most potent tool for influencing economic activity. The aim above all seems to be to avoid a recession; the state of the dollar is a secondary consideration.

Indeed some US officials see an "orderly" further devaluation of the dollar as essential to restoring America's huge trade deficit. However, most of the strain is being taken by currencies such as the euro and sterling and the economies they represent; the Chinese renminbi remains stubbornly linked to the dollar, with comparatively little prospect of a radical change in its value.

The Bank of England, meanwhile, seems increasingly likely to leave rates on hold when the Monetary Policy Committee reports on Thursday week.

Comments from Kate Barker, a member of the MPC and a "swing" voter, suggested no change. She said: "We [the MPC] are asking ourselves if things are so different from August and do we actually have to cut rates?"

Another member of the MPC, the "doveish" David Blanchflower, however, has not changed his general stance. He voted for a cut last month (in a minority of one) and repeated last night: "I believe there is considerably more slack in the labour market at present than is popularly held to be the case."

British exporters have shown surprising resilience in the face of adversity. The pound has been strengthening more or less continually against the dollar since the start of 2006, with manufacturers showing remarkable bullishness in the circumstances.

However the employers' group the EEF issued a warning last night. Chief economist, Steve Radley, said: "A weak dollar is making life more difficult for companies and there are signs emerging that some companies are finding it more of a challenge. But a strong world economy and the fact that their costs are spread across the globe have cushioned UK manufacturers from its worst effect."