Pound hits a peak as City bets on rates

Sterling hit its highest level against the euro for a year yesterday as fresh proof of the strength of Britain's economic recovery had the City betting on further increases in borrowing costs.

Two rises in interest rates since November have failed to take the heat out of the housing market, the Halifax bank reported, while a separate survey showed that the linchpin services sector expanded strongly last month.

Mounting evidence that consumers are shrugging off higher borrowing costs presents the Bank of England's monetary policy committee with a dilemma at its meeting today.

Few analysts are expecting a change when the MPC announces its decision at midday, given that the Bank promised last month it would take a cautious approach to further rate rises.

"Strong activity data along with further rapid rises in house prices supports a further rate hike, but the BoE's gradual, gradual approach suggests the next move will be delayed until May," said John Butler, a UK economist at HSBC.

Services companies, which make up two-thirds of the economy, last month recorded their highest orders for new business since May 1997, according to a survey by the Chartered Institute of Purchasing and Supply.

"Clients, confident that the domestic and global economic recoveries would be sustained, were reported to be increasingly active in February," the institute said.

The overall activity index slipped slightly from 59.8 in January to 59.5 last month but remains well above the 50 mark that indicates the sector is expanding.

With markets betting on rates rising to 4.50% from their current level of 4% by June, sterling was once again in favour with international investors. The pound set a one-year high against the single currency at 66.11 pence per euro in midday trading before dipping back to 66.31p.

House prices notched up another strong rise last month, with more than £2,300 added to the value of a typical property, indicating that two interest rate rises have done little to take the heat out of the market, the Halifax said.

Prices rose by 1.6% in February, which means an average home is now worth 17.8% more than a year ago. This annual rate of house price growth has been rising steadily since November - in defiance of the doom mongers predicting a slowdown or a property market crash.

Rival mortgage lender Nationwide last week highlighted the continuing strength of the property market when it said house prices increased by 3.1% last month.

The combination of a strong labour market, historically low interest rates and low mortgage payments as a proportion of earnings are helping to drive the market onwards and upwards, said Shane O'Riordain, the bank's group economics general manager.

A shortage of homes for sale has added to the upward pressure on prices, he said. "The level of housebuilding remains very low compared with previous decades and is failing to keep pace with the projected rise in the number of households over the next 20 years."

The average home now costs £148,089, compared with £125,571 a year ago, said the Halifax.

The two base rate rises in November and February had only a "modest" impact on housing affordability, with mortgage payments as a percentage of earnings nudging up from 13.9% to 15.5%.

This remains well below the long-term average of 21%, said Mr O'Riordain.