LONDON, July 1: Sterling retreated against the mark, falling as much as a pfennig from the five-year high it set overnight, after a survey showed its strength is weighing on UK export growth and manufacturing activity. The Chartered Institute of Purchasing and Supply (CIPS) reported its June purchasing managers' index dipped to 53.4 from 54.4 in May and said the strength of the pound "significantly subdued domestic demand."

While the strength of domestic demand and a pick up in growth overseas helped offset some of the damage, output growth fell to 55.0, the lowest level so far this year, the CIPS said.

Coming a day before the UK budget, the PMI survey fuelled expectations that Chancellor of the Exchequer Gordon Brown needs to use fiscal tightening to curb domestic demand rather than using monetary policy to do all the work.

"Manufacturing is still expanding but softer exports are tempering the position," said Tim Fox, treasury economist at Standard Chartered. "People are nervous before the budget and the numbers were used as an excuse for profit-taking."

Sterling/mark was at 2.9018/28 at 10:40 GMT from 2.9026/36 late Monday in Europe. It hit 2.91 in Asia, its strongest since June 1992. Cable was at $1.6638/43 from $1.6640/45 yesterday.

Hopes of rate rises have boosted the pound more than 20 percent against a trade-weighted basket of 20 currencies since August 1996. It has climbed as much as 4.75 percent against the mark and 2.3 percent against the dollar in the past month alone.

Today's data highlighted the toll sterling's rise is taking on UK exporters. Leaving interest rates to do the bulk of the work in the fight against inflation risks driving the pound higher and further denting the export industry, analysts said.

"The PMI supports the market's belief that sterling is overvalued and will be deterimental to the health of UK manufacturing," said Paul Meggyesi at Deutsche Morgan Grenfell. "But the market does not care about that at the moment because this is not expected to interfere with the outlook for monetary policy over the next three to six months," the currency strategist said.

September short sterling rose in the wake of the PMI numbers, and was last up four basis points at 92.91. Still, this implies rates of more than 7 percent at the end of the third quarter, compared with the current base rate of 6.5 percent.

Traders will likely hold off pushing the pound much higher before they see whether Brown tightens fiscal policy by more than the four billion pounds expected by analysts.

Sterling will be vulnerable to setbacks if he does. It will extend its losses if the Bank of England's monetary policy committee leaves rates unchanged after its meeting next week.

"The smart money is not looking to buy at the current levels, given there may be a pullback in the pound after a tight budget," said Meggyesi at Deutsche Morgan Grenfell. "Also sterling bulls are looking for a half-point rate rise next week so there may be some disappointment there."

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.