Positive sentiment surrounding the British economy has spurred a winning streak for the pound, but some analysts are not convinced its strength is here to stay.
The U.K. economy grew 0.8 percent in the first quarter of 2014 on the previous quarter, below expectations of a 0.9 percent rise, but up from 0.7 percent growth in the fourth quarter of 2013. The sterling was little changed against the U.S. dollar following the data release, and closed Tuesday in U.K. trading at around $1.6825.
"The sterling has strengthened by more than 10 percent since last July as the pace of growth in the U.K. has fueled speculation that the U.K. Monetary Policy Committee (MPC) will raise interest rates more quickly than the U.S. Fed (Federal Reserve). But we think sterling will struggle to maintain its current level," said Capital Economics' economist Jack Allen.
"We are forecasting a slight depreciation of sterling against the U.S. dollar, from around $1.68 today to $1.60 by the end of the year," he added.
Allen highlighted a number of worrying signs for the U.K. economic recovery including the fact that GDP growth remains below its pre-crisis peak.
"On the face of it, this suggests that there is more spare capacity in the U.K. than in the U.S., where gross domestic product is more than 6 percent above its 2007 high," he said. If an economy has excess capacity it's not producing to its full capability.
Capital Economics' Allen noted the U.K. economy faces larger constraints down the line, including higher debt levels and a bigger fiscal squeeze. He said this will be reflected in the inflation outlook, which will fall to around 1 percent by year end (from 1.6 percent in March), while U.S. inflation will to rise to 2 percent in early 2015 in their view.
"Accordingly, we think the MPC will keep monetary policy on hold for slightly longer than the Fed. While we are forecasting the Fed to begin raising interest rates midway through next year, we think the MPC will wait until Q4 before following suit," he added.