Sterling inched higher against the dollar and euro on Friday as investors refocused on the prospect of the Bank of England raising interest rates in the coming months, after fears of a China-led global "currency war" subsided. The pound had hit a one-month trough of 71.70 pence per euro earlier in the week after China devalued the yuan and as commodity prices plunged. Investors who had held euro-funded positions on risky emerging market currencies bought back the single currency.
But with the yuan stabilising after China eased fears the devaluation was a deliberate attempt to give it competitive advantage, appetite for risk increased. Sterling was 0.3 percent higher against the single currency on Friday at 71.21 pence. "Uncertainty around the change in the yuan regime led to the market pushing BoE rate hike expectations further out," BNP Paribas FX strategist Sam Lynton-Brown said.
"Now that that appears to be stabilising, and the market appears to be in less of a panic mode, it can focus more on the UK's domestic situation, which we view as relatively upbeat." Doubts over whether the Federal Reserve could raise US interest rates as soon as September, which many had been betting on, in an environment of sliding commodity prices and slowing growth in China, also saw the dollar decline over the week. Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ, said the dollar was more vulnerable than the pound to global economic developments in the short term because the Fed was closer to raising rates.
The pound was around 0.2 percent up against the dollar at $1.5646 on Friday, with the greenback also weakened by a fall in US consumer sentiment. For the week, sterling was up around 1 percent against the dollar, on track for its best performance in almost two months. Construction data showing British construction output returning to moderate growth in June appeared to have no impact on the pound.
Sterling had lost ground on Wednesday after data showed British wage growth slowed more than expected in June, taking some pressure off the BoE to raise rates. A Reuters poll released on Thursday showed economists still expect a rate hike early next year, but conviction was wavering. "Sterling looks well positioned to bounce against the majors, but investors (would be) better keeping things light before inflation data and retail sales next week," Citi bank currency strategist Josh O'Byrne wrote in a research note.