Pound edges higher, outperforming as investor nerves rattle euro zone markets 

By Amanda Cooper

LONDON, Oct 22 (Reuters) - The pound edged up on Thursday, as outflows from euro zone assets saw UK stocks, bonds and the currency outperform other markets in the region.

Expectations that the Bank of England will raise interest rates next month are also supporting the pound, following higher than expected UK inflation data this week.

Sterling was up 0.1% on the day at $1.34, making it one of the stronger performers, aside from the safe-haven Japanese yen and Swiss franc.

Money markets show traders expect the Bank of England to deliver at least three quarter-point rate hikes by April, with the first one priced in for the November 5 policy meeting, compared with roughly two hikes by the European Central Bank, thereby widening the interest-rate differential that fuels carry trades.

These are lucrative rate-plays that involve borrowing a lower-yielding currency, in this case, the euro, to sell it and fund investment in a higher-yielding currency like the pound.

Investor concern about high oil prices, the cost of the AI buildout and the ability of developed-market governments to bring down their huge debt loads rattled riskier assets, particularly in Europe, where French bond yields rose to new 24-year highs and euro zone stocks fell sharply.

UK gilt yields were flat on the day, against steep rises in yields on French, Italian and Belgian debt, while the FTSE 100 fell 0.6% but outperformed the STOXX 600, which was down 1%. 

Over the course of the last month, the pound has been the best-performing major currency against the US dollar, up 0.3%, while the euro is the worst-performing, with a loss of 2%. 

The euro is heading for a fourth straight week of declines against the pound, having lost another 0.5% so far this week, which brings its decline for the year to 1.8%. If sustained, this would be the euro's largest monthly drop against the pound since May 2023, when it fell 2%. 

"It looks like there is both independent sterling strength and independent euro weakness at play in euro/sterling. Earlier this summer, we had felt that sterling gains would not last. But now greater market confidence in a Bank of England tightening cycle – we look for 25-bp hikes in February and November – makes sterling a high-carry European currency," ING strategist Chris Turner said.

The concern building over the ability of the French government to tackle its finances is also taking its toll on the euro, which traders are betting will fall further against the pound. The options market shows traders are at their most negative over the prospects of the euro against the pound since mid-2024, according to LSEG data.

UK finance minister John Healey delivers his first budget on October 28, which major investors expect to pass without rattling markets unduly.

(Reporting by Amanda Cooper; Editing by Susan Fenton)