Sterling rallies

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Sterling hit a 2and half month high against the euro on Thursday, with worries about the eurozone debt crisis and rising Spanish borrowing costs outweighed a drop in UK factory output.

Bank of England policy makers voted to keep interest rates on hold at 0.5% and the quantitative easing total unchanged at £325 billion. The unchanged policy was widely anticipated by the market and meant investors were more focused on developments in the eurozone. Worries about Spain’s finances intensified as Spain only sold €2.95billion worth of 10 year bonds against an expected €3.5billion; renewing concern that the country would need a bailout.

Sterling came under pressure after data showed a surprise fall in the UK manufacturing output that slumped by 1.0% in February, it was the biggest monthly fall in almost 1 year. However despite the sharp fall, the data was outweighed by an improvement in UK services, manufacturing, and construction PMI’s (purchasing managers indexes) last week that fuelled hopes the country could avoid slipping in recession. Strong UK PMI numbers contrasted with the euro zone PMI surveys which have edged below 50, marking a contraction in activity and fanning demand to buy the pound against the euro.

As a result sterling's position against the euro rebounded and it came within a dozen ticks of the January high yesterday and went for another look early this morning. Back in mid-December the pound broke above its four-year moving average; right now it is threatening the five-year moving average. As technical signals go, this is not one of the most compelling but an upward break could give sterling the momentum to test the high of June 2010, which is only two and a half cents distant. History teaches that the pound is more likely to retreat from here than to advance, if only because there will be a queue to sell pounds at a 19 month high. But that does not rule out the idea of a higher GBP/EUR.

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