January 24, 2007 | posted by Michael Baxter in IABN |

Nigel Lawson would have seen it as a major victory against inflation. The pound surged again on global currency markets yesterday, moving within just a cent of $2 to the pound at one point, and passing a 14 year high, while it hit 241.42 yens, the highest level since 1992.

You may recall Mr Lawson, the chancellor under Margaret Thatcher, and now almost as famous for being the father of a well known chef, had this big idea for fighting inflation. He thought that by maintaining a strong pound, and in particular shadowing the deutsche mark, the fight against inflation would be won.

For a while, Mr Lawson, was considered by many to be Britain’s best ever chancellor, until the Lawson boom and bust spoilt his legacy. Along with Geoffrey Howe, he urged Mrs T to let the UK join the European Exchange Rate Mechanism (ERM), as a way of formalising the relationship between sterling and the German currency.

In order to keep the pound strong, Mr Lawson kept the rate of interest high - but much higher than it is today.

Now forward wind the clock to 2007, and we see a similar circumstance, but underlined by different economic policy.

Today, it’s all about fighting inflation by keeping a lid on demand through playing with interest. But there’s a side effect, a high rate of interest here, coupled with talk it will rise again, while it is thought rates in the US may have peaked - has led to investors pouring their money into Blightey.

The latest thinking in Japan is that it’s possible rates may have peaked already - at just 0.25 percent; and this huge differential between the cost of borrowing in Japan, and the return on saving in the UK, is giving birth to a new wave of the carry trade, when people borrow from the banks of the rising sun, at rock bottom rates, and put their money over here, boosting the city’s coffers.

Will it continue? Will sterling pass $2? Frankly, it’s already so close that it would take a brave commentator to say otherwise.

But by the end of the year, it could go into reverse. At least that’s what Capital Economics thinks. It reckons the impact of high sterling on our balance of payments will be such that our growth in GDP for this year will fall short of the optimistic predictions that have been doing the rounds. As a result, says the economic think tank, rates will fall, bringing sterling down in their wake.

Also, bear in mind that as our balance of trade has such a massive deficit, there are good reasons for the pound to fall. It’s the booming city and high interest rates that are keeping it high, the fundamentals say sterling should fall.

Editors foot note: The UK joined the ERM at 2.95 deutsche marks to the pound. When the euro was formed, the German currency was converted at the rate of 1.95583 deutsche marks to the euro. Today there are 1.5214 euros to the pound, and that works out as the equivalent of 2.9756 pounds to the old deutsche mark. 15 years on, from when George Soros made his fortune from dumping sterling, and we are back to where we started.