Market Watch : Pound Is Gaining, and You Can Gain With It

Britain has become mighty expensive lately for American tourists, thanks to the skyrocketing value of the pound against the dollar.

Many foreign currency traders think it’s almost a sure bet that the pound--currently trading at about $1.80--will rise further. So American investors might be wiser to stay home and let their money do the traveling to Britain--in the form of shares in specialized mutual funds, British government bonds or even “currency forward” contracts.

Foreign currency speculation is always very risky for small investors, and there is certainly no guarantee that sterling will continue to rise against the dollar and other major currencies. Some traders say the bulk of the run-up already has happened.

Nevertheless, there seems to be a consensus that the same causes that have sent the pound soaring since the beginning of June probably will propel it even higher. British interest rates are very high--bank base rates are at an exceptionally steep 15%--as Margaret Thatcher’s government attempts to rein in inflation. The hefty interest rate paid on bonds and short-term obligations is sucking in money from foreign investors, helping to keep the pound high. Indications are that Thatcher and her chancellor of the exchequer, John Major, aren’t likely to ease up on rates any time soon, although they probably will come down before a British general election expected sometime next year.

In addition, the British government in recent months has given strong signals that it finally is committed to bringing the pound into the European Community’s system of semi-fixed exchange rates, possibly as early as this fall.

Although most European Community currencies have been part of this system for years, Britain has been the main holdout. Bringing the pound into the European Monetary System’s exchange-rate mechanism would peg the pound to trading within a narrow band relative to the West German mark. This would eliminate much of the pound’s volatility. Traders say this also would eliminate much of the currency risk from investing in British securities.

In addition, currency experts expect that for British domestic political and economic reasons, the country will wait until the pound is at a particularly high level before bringing it into the exchange-rate mechanism. If this actually happens, then the pound would be virtually guaranteed to remain stable for some time at the higher rate.

Peter Spencer, an economist at Shearson Lehman Hutton Securities in London, said he thinks now might be a relatively safe time for smaller investors to think about making a play in sterling. “I have always been slightly reluctant to recommend the pound, because the government showed absolutely no commitment to holding its value steady in the international markets,” Spencer said. But now that Thatcher has endorsed participation sometime soon in the exchange-rate mechanism, “I think I could wholeheartedly recommend people to look at sterling assets.”

A chief foreign exchange trader for one U.S. money-center bank, who asked not to be identified, said: “I don’t think it’s near the end yet,” adding, “All major currencies are going to appreciate in U.S. dollar terms.” Because of high interest rates in Britain, which make the pound a “high-yield currency,” he said, “sterling is the surest bet at this point.”

Andy Robertson, foreign exchange sales manager for Chase Manhattan Bank in New York, and Mark Austin, a treasury economist at Hongkong & Shanghai Bank in London, predicted that sterling in coming weeks will top out at about $1.85.

Robertson recommends that investors wait until sterling is at the low end of its current trading range, at something below $1.80, before investing. “Below $1.80, sterling represents pretty fair value,” he said.

The pound dipped Wednesday to $1.799, caused by profit-taking and other developments. But the announcement Thursday by Federal Reserve Chairman Alan Greenspan that the Fed probably will begin easing U.S. interest rates weakened the dollar and sent the pound back up.

The easiest way for small investors to make a play on sterling is to buy shares in mutual funds that invest in sterling forward contracts and sterling money market securities. Forward contracts are agreements to exchange a specified amount of one currency for a specified amount of another at a future date. Fidelity Investments, for example, offers the Sterling Performance Portfolio, which invests in money market instruments and forward contracts. The price of shares in the fund has risen about 17% since the beginning of the year, a Fidelity fund manager said.

A number of firms also offer foreign currency mutual funds that don’t invest exclusively in sterling but which have heavy investments in it.

One caveat is that expectations for both the pound and the dollar could easily change. A sudden change in the political situation in Britain--for example, a development that made it seem that the Labor Party might unseat Thatcher in a general election--could send the pound tumbling. Similarly, a decision by Thatcher’s government to delay joining the exchange-rate mechanism could cause a sudden plummet. And a resurgence of the dollar against major world currencies, although not currently expected, obviously would weaken the pound’s value in dollar terms.

John Hickling, a portfolio manager for several international funds at Fidelity, warns that “if something were to happen to sterling, and it were to come back down for whatever reason, (individual) investors could lose the equivalent of six months or a year of interest payments relatively quickly.” He notes that “currency markets tend to move quickly when things change.”

On a day-to-day basis, the pound, like other foreign currencies, is frequently influenced by events that smaller American investors are likely to hear about only after the fact. For example, the pound’s dip on Wednesday was caused in part by the appearance of an article in the British magazine The Spectator, in which Nicholas Ridley, the British secretary of trade and industry, accused West Germany of trying to dominate the Common Market. (Ridley resigned over the weekend.) Currency markets interpreted this as a sign that the British government may be having second thoughts about the European Monetary System, although Thatcher disavowed Ridley’s remarks.

A few U.S. banks also have begun offering accounts denominated in foreign currencies such as sterling, which offer attractive interest rates on term deposits. This saves an investor the trouble of arranging to open an account with an overseas bank.

For those who expect the London stock market to remain bullish, investors might also consider investing in British stocks. But analysts caution that the high pound could make British exports more expensive and therefore less competitive on the world market. This could have a negative impact on earnings.