Sterling touched a 20-month high against the euro today after Bank of England Governor Andrew Bailey sent a fresh signal that the central bank is gearing up to raise interest rates as inflation risks mount.
Sterling has gained 5.5% against the euro this year.
Analysts point to expectations the Bank of England will raise rates as a main factor supporting the pound, while the British economy struggled with a shortage of labour, an energy crisis and rising Covid-19 cases.
During an online panel discussion on Sunday organised by the Group of 30 consultative group, Bailey said the Bank of England will "have to act" in its monetary policy meetings on the risk of medium term inflation.
He said he continued to believe that the recent jump in inflation would be temporary, but that a surge in energy prices would push it higher and make its climb last longer.
Overnight, sterling jumped versus the euro to its highest of 84.25 since February 2020. But it had lost some steam this evening and was trading at 84.5 pence.
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Against a strengthening dollar, it edged 0.2% lower at $1.3717, but not far from a one-month high touched on Friday.
The Bank of England looks set to be the first major central bank to raise interest rates since the beginning of the pandemic. Investors are betting on a rise to 0.25% by December.
Investors are waiting for September inflation data for Britain due on Wednesday.
Victoria Scholar, Head of Investment with Interactive Investor said those comments from the Bank of England governor were contributing to the strength in the pound today, but she added that the currency had been gaining in recent days on speculation of an interest rate hike coming down the tracks.
"It comes off the back of a period of weakness that we saw earlier this year. We saw the pound drop to its lowest level for the year a few weeks ago, but there is the potential there that we could become the first big Central Bank to raise rates this year or early next year," she said.
Ms Scholar pointed out that the UK economy could be on course for an inflation rate as high as 4%, or even 6%, next year against the backdrop of labour shortages and supply chain issues.
She said there was a risk that hiking interest rates could derail the economic recovery that's been taking hold.
"The goal of higher interest rates is to curb rising price levels. The risk is that they will weight on our economic recovery out of the pandemic. So it's a very fine balance to strike," she said.
"All sectors of the economy are still smaller than where we were before the pandemic and last week we saw the IMF downgrade its outlook for UK GDP."