Sterling rose to one-week highs against a trade-weighted currency basket on Tuesday, after stronger than expected UK housing data dampened minority expectations for an interest rate cut this week.
A survey from mortgage lender Halifax showed house prices rose 1.3 percent in December, confounding expectations of a fourth straight monthly fall but still taking the three-month annual rate of increase to a 2-year low.
The report gave investors a chance to take profits on aggressive selling during the first few days of 2008 that took the pound to 4-1/2 month lows versus the dollar, 1-1/2 year lows versus the yen and record troughs against the euro.
"There was quite a lot of bearish positioning on sterling right at the beginning of the year ... and there's been a certain amount of profit taking," said Robert Minikin, senior FX strategist at Standard Chartered.
"There is also hesitation over positioning ahead of the Bank of England monetary policy committee meeting. Many market participants are convinced that the BoE will have to ease aggressively, but whether they will ease as soon as the January meeting is a difficult call."
Standard Chartered is among the 51 economists forecasting unchanged rates on Thursday according to the latest Reuters poll, while 12 banks are going for a cut. On the BoE's trade-weighted basis sterling rose as high as 96.90, recovering from a four-year low of 96.30 set at the end of last week. By 1513 GMT, the pound was up 0.4 percent at $1.9764, over a cent above the previous day's 4-1/2 month lows.
The euro edged down to 74.47 pence, but stayed in sight of record highs at 74.93 set on Friday. The pound shrugged off data from the British Retail Consortium overnight showing December retail sales growing at their slowest pace since March 2006.
But analysts said the numbers confirmed a none-too-rosy outlook for the UK economy this year, and thus backed the case for lower rates - even if the BoE waits until February before cutting from the current 5.50 percent. Short sterling futures are pricing in 100 basis points worth of rate cuts by end-2008.