LONDON: Sterling hit an 18-month high against the euro and recovered ground against the dollar on Tuesday, after data showed Britain's industrial output expanded at its fastest annual pace in more than three years in April.
The euro fell 0.3 percent to 80.64 pence after the data from around 80.80 pence beforehand.
It equalled an 18-month low struck last week after the European Central Bank cut interest rates and announced other easing measures to ward off disinflation in the euro zone.
By contrast, the latest UK data added to growing expectations the Bank of England may tighten interest rates in early 2015 Industrial output rose by 0.4 percent on the month, as forecast, to leave it 3.0 percent higher than a year ago, its biggest rise since January 2011.
Manufacturing output also rose by 0.4 percent in April, in line with expectations.
The diverging policy outlook has pushed the difference in yields between British and German 10-year government bonds to its widest since 1997.
Analysts said the divergence should underpin the pound in coming weeks, especially with the ECB set to impose negative rates on excess cash deposited with it.
That is likely to make the euro a funding currency - one investors borrow to buy a higher-yielding currency.
"This (the industrial data) should set a tone for this week's sterling trading, with labour market data tomorrow expected to lend additional support to the pound," said Petr Krpata, currency analyst at ING.
"We prefer to fund long sterling positions with euros rather than the dollar." Sterling gave up earlier losses to turn higher against the dollar after the data. It was last trading at $1.6809, up from around $1.6788 beforehand.
The prospect of the BoE raising rates well before central banks in Europe and the United States, reflecting an economy that is doing better than many of its peers, is at the heart of sterling's surge over the past year Sterling trade-weighted index has risen 7 percent in the past year with more gains likely if data continues to paint a robust picture of the UK economy.
"A break above $1.6850 would open the way for a move towards the May $1.7000 highs, and then our 1.7100 target," Morgan Stanley said in a note.
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