Pound dives on fears of higher rates in Germany

The pound fell yesterday to its lowest level on the foreign exchanges since June after the Bundesbank kept investors on tenterhooks about the prospect of an increase in German interest rates. Sterling fell two pfennigs, edging below DM2.90, and analysts said it could weaken further.

Expectations in the currency markets about where the next interest rate rise will take place have undergone a complete reversal, with the German central bank now considered more likely than the Bank of England to be the next to act against the danger of rising inflation.

In its weekly announcement, the Bundesbank left the rate at which it will repurchase securities unchanged at 3 per cent yesterday. But it is widely expected to raise official interest rates before long unless the German currency strengthens further, so the weekly repo was followed by a bout of selling pounds and dollars for marks in thin trading.

If German interest rates do go up, it would be their first increase for nearly six years.

Bronwyn Curtis, an economist at Nomura, said: "The threat of raising rates is more potent than actually doing it, but nevertheless we have to take seriously the fact that the Bundesbank might take action."

The threat was given added force by figures on Monday showing that consumer price inflation in western Germany had climbed to 2 per cent in August from 1.7 per cent the previous month. Inflation in the six months to August, at an annual rate, climbed to 2.3 per cent, suggesting that it is picking up further.

Analysts gave the Bank of England credit for talking down the pound with its statement earlier this month that UK interest rates will stay unchanged for the time being. Trade figures due this morning are expected to reveal damage to exports caused by the pound's climb during the past 18 months.

The Bank has successfully trimmed market expectations about how high interest rates will need to rise to keep inflation on target.

A weak dollar has also contributed to the recent decline in the value of sterling. The dollar also lost two pfennigs against the German currency yesterday, falling below DM1.80 to a five-week low.

News of a decline in durable goods orders in the US last month did nothing to support the currency, with the risk of the Federal Reserve raising interest rates still considered remote.

Orders fell by 0.6 per cent in July, although their June increase was revised up to a buoyant 2.9 per cent. The figures have been volatile in recent months, and July's decline was blamed on lower defence sales and a drop in aircraft orders. Even the strike at parcel delivery firm UPS played a part, with many orders not booked until they are shipped and paid for.

Even so, economists said the figures showed the economy was still delivering steady growth with no sign of inflation.