LONDON: Sterling hit an 18-month high against the euro and hovered near a 5-1/2 year high versus a basket of currencies on Tuesday, after data showed Britain's industrial output expanded at its fastest annual pace in more than three years in April.
The National Institute of Economic and Social Research, a think-tank, later forecast robust growth for the British economy, bolstering the case for tighter monetary policy.
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 raise 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.
NIESR estimated Britain's economy grew by 0.9 percent in the three months ending in May compared with 1.1 percent in the three months to April. It also said Britain's economy has finally surpassed the pre-recession peak it reached in January 2008.
The diverging policy outlook has pushed the difference in yields between British and German 10-year government bonds to its widest since 1997. Lower short-term money market rates were also weighing on the single currency.
Analysts said the divergence should underpin the pound in the 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 unit.
"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 turned weaker against the dollar which was boosted by higher U.S. bonds yields. Treasury yields picked up after data showed wholesale inventories rose more than expected in April, boosting the chances of a sharp expansion of growth in the second quarter.
Sterling last traded at $1.6755, down 0.3 percent on the day.
Nevertheless, sterling trade-weighted index rose to 87.3, its highest since May 21 and equalling a level last seen in late 2008. The index has risen 7 percent in the past year with more gains likely if data remains robust.
On Wednesday, UK labour market and wages data will be released. Economists are forecasting the jobless rate to fall to 6.7 percent in April from 6.8 percent, although wages growth is likely to slow.
"Jobless claims should extend their slide in May, adding to evidence that the slack in the economy is disappearing," Citi said in a note. "In turn, this could strengthen calls at the MPC (BoE monetary policy committee) for more policy action on rates before long."
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