Sterling rose to match a recent six-year high against a currency basket on Tuesday, after data showed British inflation sped up unexpectedly in June to its fastest rate since January, fuelling the view that interest rates will rise this year. Consumer prices rose 1.9 percent on the year in June, the Office for National Statistics said, above expectations of a 1.6 percent reading.
Sterling climbed 0.6 percent to its highest in almost six years against the dollar at $1.7192, up from $1.7078 before the data. The pound was also helped by dovish comments from Federal Reserve chair Janet Yellen, who said that while the economy was improving the recovery was far from complete.
The euro fell to a one-week low of 79.24 pence from 79.755 beforehand, down half a percent on the day and not far from its recent two-year low of 79.15. The pound's gains saw it equal a recent rise to its highest point in nearly six years against a basket of currencies, of 89.0, data from the Bank of England showed. Short sterling rate futures fell and the sterling overnight index swap curve implied a chance of a rate hike in November. Until late last week, investors were pricing in the chance of the first move in December.
Inflation had largely been declining over the past year, and remains below the Bank of England's 2 percent target, allowing the central bank to hold off on raising interest rates despite Britain's surprisingly strong economic recovery. "One of the angles for the BoE moving less quickly ... was that they had a bit of breathing space provided to them by the fact that inflation was below target," said Daragh Maher, a currency strategist at HSBC in London.
"This spike higher today means that breathing space is less, but what we don't know is how much the BoE will put on this spike." BoE Governor Mark Carney, appearing before British members of parliament, said inflation expectations were extremely well anchored and had improved over the past year. Separate data released on Tuesday showed house prices also picked up speed, with property prices in London jumping by a record 20.1 percent over the 12 months to May.
Tuesday's numbers contrast with a run of recent lacklustre data, which had helped push sterling to a two-week low of $1.7059 earlier in the day. The stronger data will support expectations that the BoE will raise interest rates for the first time in seven years in the coming months. That is in sharp contrast to the European Central Bank which is expected to keep policy easy as it grapples with disinflation.
"The best play to weigh the diverging monetary policy outlooks is to short the euro against the pound," said Jeremy Stretch, head of currency strategy at CIBC World Markets. Despite sterling's rise, there were risk factors lurking. Valentin Marinov, a currency strategist at Citi, said the risk of Scotland voting for independence could discourage buying sterling against the dollar ahead of a September 18 referendum.
A study by Morgan Stanley on Monday found that if Scotland splits off from the rest of the United Kingdom, that could see the value of sterling drop by up to 10 percent, exposing the rest of the country to more financial risk and delaying any interest rate hike until after May's general election.
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