Signs more stimulus from the Bank of England is now off the cards drove sterling to a 19-month high against the euro and a trade-weighted index and helped it climb to a two-week high against the U.S. dollar on Wednesday.
Minutes from the bank's last policy meeting showed it voted 8-1 against further stimulus, with one policymaker who had consistently voted for more monetary stimulus moving out of the dovish camp and another now seeing the decision as finely balanced.
That wrong-footed many investors who had geared up for a dovish set of minutes and this lifted the pound across the board, pushing it up 0.7 percent on a trade-weighted basis to 82.7.
More quantitative easing is considered to be negative for the currency as it involves flooding the market with sterling. So with the latest BOE minutes suggesting more stimulus is now off the table, sterling is likely to trade firm.
Having expected the voting pattern to match last month's outcome, the markets were surprised by arch-dove Adam Posen's change of heart, voting for no change to the quantitative easing programme, said Alex Lawson, senior broker at Moneycorp.
The one member who voted to expand the Bank's asset purchases, David Miles, said that his decision was finely balanced - reducing the chances for more stimulus in the coming months.
The euro fell to 81.74 pence, its lowest level since end-August 2010, breaking past reported option barriers at 82 pence and 81.75. Near-term support is expected around 81.43 pence, a level seen on June 23, 2010. A break below that could see it ease towards 80.67 pence, the 2010 low.
We stick with our view that euro/sterling breaks below 80 pence, said Chris Turner, head of currency strategy at ING.
We have been very positive on sterling all year, but progress to the upside has been frustratingly slow. This probably owes to the UK's status as an old economy undergoing necessary re-balancing towards the external sector - plus an external sector skewed to the euro zone.
EURO ZONE HEADWINDS
Given the UK's large exposure to the crisis-hit euro zone, both through trade and financial links, sterling has often found it tough to rally against the safe-haven dollar.
But on Wednesday, sterling rose to a two-week high of $1.6000, in sight of its recent four-month highs of $1.6063 hit earlier this month. Traders said Asian central banks were selling the British pound at higher levels and sterling was last at $1.5973, up 0.3 percent on the day.
Still, the medium-term trend for sterling looked bullish on the charts with some pointing to a golden cross, with the 55-day moving average poised to cross the 200-day moving average.
A golden cross would be formed if the former rises through the latter and last time it happened in September 2010, sterling rose from around $1.5400 to above $1.6500.
We think sterling can strengthen further because stopping QE effectively stops devaluing the pound, said John Wraith, head of rates strategy for Bank of America Merrill Lynch.
Lingering expectations that the U.S. Federal Reserve could still resort to another round of easing is likely to support sterling against the dollar.
Analysts said the latest UK data also surprised on the upside. Unemployment fell by 35,000 in the December to February period while the unemployment rate fell to 8.3 percent from 8.4 percent - the lowest level since last summer.
Still, the UK's labour market is at best sluggish, domestic demand patchy and an economic recovery uneven. So while the signs of a slight recovery lessen the need for further stimulus, a rapid deterioration in the euro zone crisis could worsen the UK's outlook and drive the BOE towards easing.
(Reporting by Anirban Nag; editing by Stephen Nisbet)