Stirling rises against dollar, euro

London - Sterling rose against the dollar and the euro on Friday after data showed the British economy had grown more than initially estimated in the second quarter, lifting prospects that interest rates may rise sooner than the Bank of England has signalled.

Gross domestic product expanded 0.7 percent on the quarter, beating the initial reading and consensus forecast of 0.6 percent.

The pound was last up 0.2 percent at $1.5624, having hit a session high of $1.5638 after the data. It was still some way off a two-month high of $1.5718 struck on Wednesday which was acting as resistance, while support lay at $1.5574, the Aug. 8 high.

Traders said sterling gains were capped as sellers emerged at the $1.5620/40 level.

The euro was down 0.2 percent at 85.48 pence, after slipping to the day's trough of 85.42 pence, but staying above the 1-1/2 month low of 85.05 pence struck last week.

“These (GDP) figures came as a little bit of a surprise and that is why we saw the (pound) break back above that $1.56 level but I don't think it is enough to push it much higher than here,” said Kathleen Brooks, research director at FOREX.com. “Data out of the UK could help the market potentially challenge the BoE's pledge to keep rates low until 2016.”

BoE Governor Mark Carney earlier this month pledged to keep UK interest rates low until unemployment falls to 7 percent, which the central bank sees as unlikely for another three years.

Improving economic conditions have cast doubt on that timetable and helped sterling gain more than 2.5 percent against the dollar and around 2 percent against the euro this month.

At the short end of the curve, sterling overnight interbank average rates (SONIA) inched towards pricing in a first rate rise in 18 months. The two-year SONIA rate was at 0.56125 percent while the 18-month rate was at 0.48750 percent, pointing to increased bets of a BoE rate hike in 2015.

In a reflection of increasing expectations that the BoE could lift rates earlier than indicated, short sterling rate futures were down across the strip.

The pound rose against the dollar as the yield premium that the 10-year U.S. Treasury notes offer over gilts narrowed slightly.

But analysts cautioned that sterling's gains would be capped against the dollar on growing expectations that the U.S. Federal Reserve will be the first major central bank to pare back its stimulus, possibly as early as next month.

In contrast, they expect BoE chief Carney to talk down a sharp rise in UK market interest rates, perhaps as early as next week, and reiterate his pledge to keep rates low until unemployment falls to 7 percent as laid out in the forward guidance.

Morgan Stanley analysts warned that the pound is overvalued and that it “now stands out as the most vulnerable of the G10 currencies.”

“We also expect BoE officials to address the recent rise in rate expectations,” they said, adding that they remain bearish on the currency and a move below $1.5550 would trigger a renewed bearish signal. -Reuters