Sterling hit a three-week high against the euro on Wednesday, recovering from early losses as investors squared short positions in the currency ahead of an announcement on interest rates later in the week.
The UK currency rallied more than 1 percent against the dollar, climbing above the psychologically key $1.50 level for the first time since mid-December, as the dollar suffered broadly due to a dismal reading of U.S. private sector jobs.
The Bank of England began a two-day monetary policy meeting on Wednesday, and most investors expect a 50 basis point cut in the base rate from 2.0 percent, with the chance that a bigger cut may be in store to cushion the blow of a deteriorating economy.
At the same time, UK media reported the shadow Monetary Policy Committee believes rates should be held at 2.0 percent while the central bank focuses on other measures to boost the economy, including so-called "quantitative easing".
Given that the size of a cut may be anyone's guess, market players said traders were wary of being heavily positioned for or against sterling, prompting some to close short positions.
"Running a position heading into tomorrow's meeting could be tricky, when the Bank could cut 25, 50, 75, or even 100 basis points or nothing," said Maurice Pomery, head of currencies at IDEAglobal in London.
"That explains why people are book-squaring quite heavily that the moment."
The pound rallied against the euro, which fell half a percent to 89.60 pence according to the Reuters dealing system, breaking under the key 90 pence level for the first time since mid-December.
Some analysts say the euro's broad slide in the past week or so from a record high around 98 pence may have put parity between the two currencies out of reach.
Sterling climbed more than 2.2 percent to $1.5285, also its highest since mid-December. The dollar came under selling pressure after a weaker-than-expected reading of U.S. private sector jobs.
Some market participants said sterling was also supported by demand related to speculation for increased foreign investment, on the view that a weak currency, cheap shares and tumbling real estate prices were raising the appeal of corporate investments in the UK from overseas.
Analysts said sterling was supported after recovering from heavy losses, partly on the view that interest rate cuts and government stimulus plans will help the economy recover from a recession faster than in the euro zone.
"The market is still cutting out short sterling positions and there's fresh corporate-style money from abroad coming into the UK," said Neil Jones, head of European hedge fund sales at Mizuho Corporate Bank in London.
"There's been a change in sentiment for sterling."
Sterling bucked earlier losses after Marks & Spencer, the nation's biggest clothing retailer, announced that it had posted its worst quarterly sales in a decade and would cut more than 1,000 jobs as careening consumer confidence slams the high street.
The UK currency also shrugged off comments from Chancellor Alistair Darling published in the Financial Times on Wednesday that Britain is "far from through" the recession.
The Bank has slashed 3 percentage points off its benchmark rate since October to 2.0 percent, its lowest in more than 50 years and taking rates lower than the euro zone's 2.5 percent.
But some analysts say a slowing pace of rate cuts, as well as the possibility that more Bank easing may help the economy recuperate faster than the euro zone, may prevent more drastic losses in the pound.
