LONDON Sterling rose against the dollar on Wednesday after U.S. lawmakers averted big tax hikes and spending cuts, but wariness about the UK economic outlook pulled it away from a 16-month high hit in Asian trade.
The pound was last up 0.3 percent at $1.6294, off an earlier peak of $1.6380, its highest since late August 2011. Gains against the dollar helped lift sterling's trade-weighted index to a two-month high of 84.2.
But traders said there was strong interest to sell the pound above $1.63 from medium-term investors, including from UK importers looking to hedge their currency exposure.
This meant the pound failed to build on its gains despite a survey showing UK manufacturing activity at a 15-month high.
"Sterling's gains have been met with medium-term sellers given the UK's uncertain long-term fundamentals... For a lot of longer-term corporate accounts levels above $1.63 are quite attractive levels to sell," said Paul Robson, currency strategist at RBS.
Traders said they had seen strong demand from UK companies looking to sell the pound at these levels.
"If you think that since the middle of 2010, sterling had traded between $1.5200 and $1.6700 we are at good levels to hedge," one London-based trader said.
Data showed the purchasing managers' index for UK manufacturing rose to 51.4 in December from 49.2 in November, well above the 50 level that marks growth in the sector and a far stronger increase than the consensus for a reading of 49.1.
But the pound showed little reaction, failing to push higher against the euro, which was up 0.15 percent at 81.33 pence, above a two-week low of 81.045 pence hit on Monday.
Jeremy Stretch, head of currency strategy at CIBC, said investors were likely to be sceptical that the UK manufacturing sector can continue to perform well, especially as the euro zone is struggling.
"Because the PMI data was so far ahead of expectations there is uncertainty about whether it is telling us the real state of the UK economy and the market is treating it with a degree of circumspection."
"There is likely to be reasonable resistance at the $1.6380 peak."
Other data recently has suggested the UK economy still has its problems, with retail sales and public borrowing weak. Construction and services PMI readings for December are due on Thursday and Friday.
The U.S. deal that averted recession-inducing budget cuts fuelled appetite for currencies which typically benefit from expectations of global economic growth, including the pound.
But some analysts warned the market's optimism could be short-lived. While immediate pain such as tax hikes for almost all U.S. households was averted, spending cuts of $109 billion were only delayed for two months.
"It will be tough for sterling to rise back above the day's high as it seems that a lot of big key levels were taken out in quick succession, riding the wave of 'fiscal cliff' euphoria," said Lee McDarby, head of dealing for corporate and institutional treasury at Investec.
Analysts also pointed to positioning data showing speculators increased bets on sterling rising in the week to December 24 and said the pound could struggle if traders start to cut back on those positions.
(Editing by Toby Chopra)