Think the pound is heading higher? Think again

Sterling surged to a 7-and-a-half-year high against a basket of trade-weighted currencies on Friday, after the head of the Bank of England (BoE) hinted at an earlier-than-expected interest rate rise. But analysts aren't convinced that the pound's strength will last.

BoE Governor Mark Carney said late Thursday that there would be a "sharper" focus on the process of raising interest rates around "the turn of this year". The comments sent the pound higher, and on Friday it was trading around $1.5618. Against the BoE's trade-weighted index, it hit 94.5 – its highest level since March 2008, according to Reuters data.

An interest rate rise usually strengthens a country's currency, but analysts said that this might not be the case when it comes to sterling against the dollar.

"We think that the U.S. Federal Reserve will raise rates at a faster pace than the BoE over the coming years and that reflects different outlooks for the economies, with the U.S. recovery more advanced than the U.K.'s," Samuel Tombs, senior U.K. economist at Capital Economics, told CNBC by phone.

Stefan Rousseau | WPA Pool | Getty Images

Tombs said that the U.K.'s "fiscal squeeze" – continued spending cuts by the government – means that monetary policy will need to remain loose for longer, in an effort to bolster the economy. In contrast, the U.S. will be on a quicker rate-hike cycle, causing a stronger dollar. He added that sterling could weaken to $1.50 by the end of this year and $1.40 by the end of 2016.

"It's a fairly big move in the next few months because we think the Fed might raise rates as many as three times by the end of the year," Tombs said.

'Overvalued' by 12%

Sterling rallied over 6 percent against the dollar between mid-April and mid-July, but it has been on a bumpy ride. Over the year to date it's up only 0.2 percent.

Indeed, one analyst told CNBC that the pound was overvalued on a purchasing power parity (PPP) basis. This theory looks at the relative value of different currencies.

If the pound is overvalued on a PPP basis, it means it is more expensive to buy an item in the U.K. (such as a big mac) than it is to buy it in another country.

"We think sterling will weaken quite significantly. It's 12 percent overvalued on a PPP basis relative to the U.S. dollar," Yogi Dewan, founder of Hassium Asset Management, told CNBC in an interview earlier this week.

Dewan added that the pound should be trading around $1.41.

But not everyone is convinced that the pound is destined to sink in the face of a dollar rally.

"Cable (dollar-sterling) will be the more boring pair this year," Kathleen Brooks, research director at told CNBC by phone.

"I don't think cable is falling this year at all, but I can see it trading in a range. We might not break above $1.60 but I don't think we will get below $1.52."

Related Tags