By Marc Jones
LONDON (Reuters) - Sterling surged on Friday after the Bank of England hinted at an interest rate rise this year, while escalating violence in Iraq drove oil to a nine-month high and dampened equity markets.
European shares were still on course for the ninth week of back-to-back gains but opened in the red, with caution restored by the unrest in Iraq and signs that, at least in some countries, the era of record low interest rates is near an end.
Bank of England Governor Mark Carney said late on Thursday that British interest rates could rise sooner than financial markets expect, in a surprisingly stark warning that monetary policy may start to tighten before the end of this year. Markets had previously been expecting a rate hike in the first quarter of 2015.
That would make the BoE the first of the four major central banks to raise interest rates.
The Bank of Japan stood pat on monetary policy as its chief Haruhiko Kuroda stressed there was no chance of the bank quitting its stimulus programme before it is confident on inflation.
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Sterling neared a five-year high against the dollar on Carney's comments and hit a 1-1/2 year high of 1.25 euros. The gap between 2-year UK and German yields ballooned to its widest in four years, reflecting how different BoE and European Central Bank policies are likely to be in the coming years.
"The BoE seems to be slightly ahead of the Fed as far as rate hikes are concerned," said Lutz Karpowitz, currency analyst at Commerzbank. "Macro data is likely to attract particular attention over the coming months. Anything pointing towards a possible rate hike would then support the pound further."
Financial markets' focus was otherwise on the rising violence in Iraq where Sunni Islamist militants have surged out of the north this week to menace Baghdad and want to establish their own state in Iraq and Syria.
President Barack Obama on Thursday threatened U.S. military strikes in Iraq against the insurgents, who gained more ground overnight.
"I don't rule out anything because we do have a stake in making sure that these jihadists are not getting a permanent foothold in either Iraq or Syria," Obama said at the White House when asked whether he was contemplating air strikes. Officials later stressed that ground troops would not be sent in.
OIL SPIKE
Oil drove sharply higher, with Brent crude slicing through $114 a barrel to a fresh nine-month high and the market looking in no mood to stop there.
U.S. crude touched an intraday high of $107.68. Both benchmarks are set to gain almost 5 percent this week, the biggest weekly rise since July 2013.
"There have been no disruptions to oil supplies so far but people are very nervous," said Ken Hasegawa, a Tokyo-based commodity sales manager at Newedge Japan.
In Asian trading the yen and gold both benefited from their traditional safe-haven statuses. U.S. Treasury yields also sagged as soft U.S. data added to the renewed sense of caution, a move mirrored by German government bonds too.
Weaker-than-expected U.S. retail sales and jobless claims data on Thursday further tempered economic optimism felt earlier in the week that had propelled Wall Street to record highs.
Taking its cue from an overnight slide in U.S. stocks, MSCI's broadest index of Asia-Pacific shares outside Japan shed 0.3 percent. Tokyo's Nikkei swam against the tide to rise 0.9 percent, on hopes for news of a corporate tax cut and taking its rise over the last three weeks to almost 9 percent.
Reaction was muted towards China's industrial output and retail sales data, which rose in line with forecasts but were not solid enough to show that the world's second-largest economy was on a solid, broad recovery.
The dollar edged up 0.3 percent to 101.97 yen but was still stuck near a two-week low of 101.60 hit on Thursday. On the week, the dollar was on course to lose about 0.5 percent against the yen.
(Additional reporting by Anirban Nag; Editing by Susan Fenton)