Sterling hit its strongest level in seven years against the euro on Wednesday, as investors bet that the Bank of England's inflation report will signal a sooner interest rate hike than markets currently expect. The euro briefly dipped below 74 pence for the first time since January 2008, before recovering a little to trade at 74.115 pence, leaving it down 0.1 percent on the day.
The BoE will publish its quarterly report on Thursday morning, with the vast majority of economists polled at the end of last month expecting the central bank to revise down its inflation projections after a dramatic fall in energy prices. Some reckon that a fall in inflation expectations would mean the BoE would keep rates lower for longer so as not to jeopardise growth. But in a speech in Dublin last month, BoE Governor Mark Carney said lower oil and food prices were "unambiguously positive" for Britain.
"My sense is that we could get a similar message (to Carney's Dublin speech) in the inflation letter, the quarterly Inflation Report, and the comments from Carney," said Derek Halpenny, European head of global markets research at Bank of Tokyo-Mitsubishi UFJ in London. "If the Bank of England believes that wage pressures are about to start building, I think the scope for being dovish and wanting the markets to push back the timing of the first rate increase is fairly limited."
Investors are currently expecting the BoE to begin raising interest rates from their historic lows next February, having until last summer expected a rate hike early this year, or even in late 2014. Sterling edged down 0.2 percent against the dollar on Wednesday to trade at $1.5225. A number of major banks have recommended selling sterling against the dollar in the past two weeks but the currency has proved fairly resilient, resisting a push below $1.50.
"On cable (sterling/dollar) our models ... indicated at the end of January that it was undervalued. They now see fair value at around $1.5250," said Michael Sneyd, a strategist with French bank BNP Paribas in London. With little in the way of domestic economic news, British government bond prices were little changed. At 1707 GMT, the 10-year gilt yield was up half a basis point on the day at 1.68 percent.