The pound, supported by a run of positive economic data, climbed to a two-year high against the dollar on Friday, rising to $1.6578.
“The UK economy is recovering faster than people expected, and we think that continues next year,” said Mark Schofield, head of macro research at Citigroup.
Traders have pulled billions of pounds out of emerging markets this year, where growth has slowed, and ploughed it into sterling.
Mr Schofield said this trend was likely to continue as concerns about political stability in the US and worries over eurozone growth weigh on the dollar and euro next year.
“People have been very bullish on dollars and been wrong, and you’ve got a lot of US political issues that are still worrying,” he said.
“France is flirting with recession, and Europe has a lot of concerns over its growth outlook … so it’s very difficult to see where capital is going to flow, other than sterling.”
Citigroup predicts the pound will rise to $1.70 against the dollar by the end of next year, up 3pc from its current level. It also believes sterling will climb to ?1.25 against the euro, from a current level of ?1.19.
Mr Schofield said the pound could even climb to $1.80 against the dollar by the end of 2014.
“The $1.70 level would be the highest we’ve traded for some time, certainly in the post-crisis world,” he said. “If it gets through that level, technically there’s not a lot stopping it from going higher [especially if] you get clearer signs of a long term structural recovery in the UK, or an uptick in US political concerns.”
However, a strong pound could hinder any chance of a manufacturing-led, export-driven recovery in the UK. Analysts said while the Bank of England has attempted to “talk down” the pound in the past, it was unlikely to take direct action.
“The UK doesn’t have a great record at intervening in the markets,” said Kathleen Brooks, research director at forex.com. “Black Wednesday 1992, when the UK was forced to withdraw the pound from the Exchange Rate Mechanism (ERM) after it was unable to support it, is still quite a sore point.
“Any hint at intervention to weaken the currency may also see hedge fund managers and the new generation of George Soros’s try to undermine any attempts by the Bank to weaken the currency.”
However, Mr Schofield said he was confident that the Bank would carefully monitor Britain’s recovery.
“The Monetary Policy Committee will continue to take a very cautious line,” he said. “It’s unlikely they’ll raise interest rates quickly or aggressively. They’ll want to make sure that the recovery is sustainable before making a move.”
Source The Telegraph