Sterling is poised to build on its broad rally as investors speculate that fiscal and economic conditions in Britain will improve faster than in the euro zone or the United States.

Technical factors are also working in the pound's favour, while lower implied volatility will help the UK currency higher.

Having cleared a number of risk hurdles, including a UK general election and an emergency budget, the pound has climbed nearly 9 percent against the dollar since May as investors have bought back massive short positions taken at the start of 2010.

On Friday, it rose as high as $1.5450 GBP=D4, near a 2 1/2-month high of $1.5473 hit last week, while the euro was at 83.50 pence EURGBP=D4, pulling away from 85.03 pence hit earlier this week.

Overall, the pound has been on a rising trend versus the euro since March as debt problems in some euro zone countries have called into question the region's financial stability.

Sterling's short-covering rally against the dollar has evolved into sustained gains, and analysts say demand will be maintained so long as the economy plods towards recovery and the government implements its plans to cut the budget deficit.

The near-term risk of serious malaise has disappeared, said Peter Frank, currency strategist at Societe Generale.

The market isn't necessarily super bullish on UK growth but it sees some growth and less credit risks. Sterling is doing well in absence of negative risks.

Other analysts anticipate that UK interest rates will rise faster than in the euro zone and the United States. While few expect any tightening will happen before next year, this view is also bolstering the pound.

Frank added that the market was maintaining short pound positions -- bets the currency will depreciate -- and that further adjustment of these positions would support sterling.

Sterling's rise versus the dollar has coincided with a cut in short positions from a record high of around 77,000 in May, according to IMM positioning data. About half of those shorts remain, suggesting the pound has more room to climb.


The pound has benefited from a run of solid UK economic data, the latest of which was a surprisingly strong growth reading for the second quarter released on Friday.

Although analysts say the economy will lose steam in the coming months as spending cuts kick in, many believe it will expand, albeit at a slower pace.

I'm willing to give the UK and sterling the benefit of the doubt, said Jane Foley, director of research at

She added that the pound would make more headway against the euro, which already has lost some 5 percent this year. In three months' time, she expects the euro to have slid to 78 pence, while the pound will consolidate around $1.51-1.52.

While the UK economy is hardly booming, optimism about the U.S. economy has soured due to a run of dismal data, which prompted Federal Reserve Chairman Ben Bernanke to say this week he was prepared to offer more stimulus if needed.

Minutes from the BoE's July meeting this month showed policymakers also discussed monetary policy easing, but many in the market say this is not their main scenario.

A deteriorating economic outlook and prolonged period of near-zero U.S. interest rates would pressure the dollar broadly lower, said Paul Mackel, director of FX strategy at HSBC, adding that this may push sterling to $1.62 before the year is out.

Technical factors also support the argument for sterling to stay buoyant, with Commerzbank analysts saying the pound's climb to $1.5473 last week saw it break it out from what had been am eight-month channel resistance at $1.5310.

Sterling was set to end the week above key support at $1.5304, the 38.2 percent Fibonacci retracement of its peak-to-trough move in August 2009-May 2010, which may open the way to the 50 percent retracement, currently at $1.5636.

Meanwhile, analysts expect the euro will struggle to post lasting gains beyond 84 pence, a low hit in June last year seen as a key resistance level.

As implied currency volatility slides across the board, one-month vol for sterling/dollar vol GBP1MO= and euro/sterling this month both hit their lowest since early 2010, and continue to hover in range of those levels.

Meanwhile, one-month sterling/dollar risk reversals GBP1MR=ICAP show a slide in sterling puts, indicating a decreasing bias to sell the pound, which market participants expect will continue barring any risk surprises.

(Editing by Nigel Stephenson)