IS it a bird? Maybe even a plane? No, what you see is Superpound, and you may even have some in your wallet. Sterling has climbed to a 26-year high of $2.02 against the dollar, boosted by the expectation of higher interest rates in Britain, which the Bank of England duly delivered on Thursday lunchtime.

When currency traders assess whether to buy or sell, the pound ticks most of the right boxes. The economy looks strong, of which more below, and there is no sign that the appetite for higher interest rates of the monetary policy committee (MPC), or at least most of its members, has been satisfied.

The performance of the pound under new Labour differs markedly from predecessors. Every previous Labour government endured sterling crises: the abandonment of the gold standard in 1931, the devaluations of 1949 and 1967, the IMF crisis of 1976. This one has had a strong pound that is getting even stronger.

Sterling’s rise against the dollar, the “cable” rate, exaggerates its overall strength. Since early last year the pound is up by nearly 30 cents. But there is also some broader-based strength. The pound’s average value, measured by the sterling index, has risen by 5% over the same period.

In one respect, the Superpound story is a simple one. For a few months last year we had the unusual situation in which British interest rates were below those in America. The Bank’s surprise January rate rise to 5.25% restored parity between UK and US rates and subsequent increases have taken British rates higher. Normal service has now been resumed and the chances of further hikes here are greater than in America. When interest rates do come back down, America is likely to lead.

The European Central Bank left its interest rates unchanged at 4% on Thursday. Japanese rates are close to zero. Canada’s Bank rate is 4.5%. UK interest rates are the highest in the G7.

The New Zealand dollar has risen 28% over 12 months, on the back of a rise in interest rates to 8%. High-yielding currencies are attractive to international investors, particularly when they borrow cheaply in yen, the carry trade. Sterling is getting some of that.

But the sterling phenomenon is not just about its rise against a sagging dollar. Michael Saunders, an economist with Citigroup, has been tracking its growing importance as a reserve currency. Sterling was the original reserve currency until about 1914, held by other governments, central banks and international institutions.

It then went into decline, along with the UK economy, overtaken in importance by the dollar, D-mark, yen and even the French franc. But sterling has made a comeback and has been the fastest growing reserve currency in recent years. The dollar is still the world’s leading reserve currency, by a mile, accounting for almost two-thirds of holdings, followed by the euro with a quarter. But sterling’s share has risen to 4.5% from 2.1% 10 years ago and moved ahead of the yen.

IMF data show identified holdings of $156.9 billion (£77.7 billion) of sterling. But, according to Saunders, this does not take into account those nations where reserve holdings are not broken down by currency. Add these, and sterling reserves on his estimate are nearly £134 billion, up more than £20 billion on a year ago.

The rise in sterling reserves is part of a wider phenomenon. UK assets have become more attractive to international investors. Figures from UK Trade & Investment (UKTI), the government body, showed that Britain had another very strong performance during 2006-7, with a total of 1,431 inward-investment projects, up by 17% on a year earlier. This was the third record year in a row.

Of these, 23% were expansions of existing investments, 42% were new, and 35% mergers and acquisitions. Inward investment, it appears, is unequivocally a good thing. The latest year’s projects created over 36,000 new jobs and safeguarded a further 41,000. According to UKTI, two-thirds of investments were by innovative or R&D-intensive firms. The great threat of firms deserting Britain for tax reasons has come to little; 200 foreign firms established UK headquarters in 2006-7.

Surely, however, there must be some downside to Superpound, and even to this flow of inward investment. Exporters suffer when sterling is strong and some fret about “UK plc” being snapped up by foreign bidders.

But there is another potential downside, highlighted by research at Nottingham University’s Globalisation and Economic Policy Centre (GEP). It suggests that inward investment has the effect of killing off promising start-up businesses in Britain, particularly innovative new firms.

The research, by Andrew Burke, Holger Görg and Aoife Hanley, highlights the strong rise in the share of UK employment in foreign-owned multinationals, from 12% in 1998 to 17%. Inward investment is beneficial, it says, in so-called “static” industries, where technologies are well established and where its effect is to improve efficiency and bring down prices. But in fast-changing “dynamic” industries, inward investment has its sinister side.

“The chance to attract a big company and hundreds of jobs to the UK may make the demise of a new enterprise seem unimportant, but the impact could be enormous over the longer term,” says Görg. “The companies being killed off are the Microsofts and Virgins of the future. Many promising start-ups are being snuffed out before they have a chance to develop competitive resilience.”

There is no easy answer to this but it is a reminder that actions have consequences, and risks. We may be quietly proud of Superpound as a national virility symbol. And the government would face a wave of criticism if the inward investment stopped coming in and there was a drain of head offices. But at some stage these inflows will fade, and with them sterling’s strength. Only then will we really know how well we are doing.

PS: Attempted terrorist attacks, floods, torrential rain, hailstones the size of golf balls (the old smaller ball, that is), the most-disrupted Wimbledon on record – a gloomy time. Then along comes the Bank, like a grim, grey countenance, to add to it. Central banks are supposed to take away the punchbowl when the party gets going, not pile on the misery at a wake.

I would not have raised interest rates on Thursday, as I wrote last week. It seems to me that some members of the MPC, including the governor, were stung by more than they cared to admit by having to write an explanatory letter in April in response to March’s inflation rise above 3%. What was, until then, a calm and measured response has suddenly become aggressive.

Retailers are genetically programmed to moan about trading conditions but for once their pain is real and, according to the British Retail Consortium, intensifying. The summer sales have come early, and the discounts deeper than usual. You don’t sell many little strapless numbers when the weather is cold and wet – I haven’t bought any.

You may say that this is just anecdotal and that as the weather improves the picture will be transformed. But the data are also convincing. Median pay settlements continue to average only 3.5%, confirming the benign wages picture. The growth in real household incomes has ground to a halt and the saving ratio is at a 47-year low of 2.1%. If this does not add up to a significant spending slowdown I would be astonished.

Even in the housing market, where the picture on prices is mixed, the seeds of a slowdown are there. To the extent housing is fuelling strong growth in the money supply, incidentally, this may be more technical than real; a function of the fact that after a period of sharply rising house prices, those entering the market have much bigger mortgages than those leaving it.

The economy is not going to fall off a cliff, particularly with the global picture so strong. But domestic demand looks to have slowed and will slow further. The Bank has demonstrated its aggressiveness. It now has to be wary of the dangers of overkill.

david.smith@sunday-times.co.uk

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