LONDON (Reuters) - Sterling hit a two-week high against the dollar on Wednesday after Britain's Chancellor did not use his budget to give as much leeway to the Bank of England to stimulate growth as some market players had anticipated.
Minutes from the latest Bank policy meeting, showing less support than expected for further asset purchases, also lifted the pound as investors who had bet against the currency were forced to cover their short positions.
The pound rose to a peak of $1.5187, its highest since early March, before paring gains to last trade up 0.4 percent on the day at $1.5163.
Strategists said sterling's bounce could be short-lived, however. Although some investors were disappointed after Chancellor George Osborne kept the BoE's inflation target at 2 percent, his updated remit for the central bank was supportive of unconventional policy measures.
That could pave the way for more aggressive monetary easing, despite sticky inflation, when new governor Mark Carney takes over in July.
"Sterling has rebounded on this news but it's a bit of a knee-jerk reaction. The fact they have emphasised the flexibility available within the current regime should allow the Bank to continue to provide this very accommodative policy," said Ian Stannard, head of European FX strategy at Morgan Stanley.
"That will allow sterling to come back under pressure."
Stannard said the pound may test resistance around the February 28 high of $1.5223, but investors should use that as a selling opportunity.
Osborne also used the budget to halve this year's growth forecast, adding to deep concerns about the faltering British economy that helped push sterling to a more than 2-1/2 year low of $1.4832 last week.
The euro edged up 0.1 percent to 85.40 pence, holding within sight of a five-week low of 85.055 pence struck on Tuesday on concerns the financial crisis in Cyprus could impact the broader euro zone.
Analysts said while problems in the euro zone could support the pound, given edgy investors look at it as a safe-haven currency in Europe, the risk of another British recession and a central bank that could aggressively ease policy in coming months would deter many investors.
Sterling was also helped higher by some investors cutting long dollar positions before the conclusion of a U.S. Federal Reserve meeting. Policymakers are expected to sustain stimulus measures to support the U.S. economy.
Earlier in the session, minutes from the last Bank policy meeting showed policymakers were still split at 6-3 on further asset purchases.
The minutes, which some were expecting to show a closer vote, also revealed concerns that further quantitative easing would lead to more sterling weakness and add to inflationary pressures.
"Clearly the wording of the minutes show some policymakers are worried about a sharp drop in sterling and we can see some push-back from them. In the short term, we could see a short squeeze, but anything above $1.5300 we will see strong resistance," said John Hardy, currency strategist at Saxo Bank.
Quantitative easing involves printing more money to buy bonds and since that increases its supply, the currency loses some of its value.
Still, options markets showed investors betting increasingly on more sterling weakness, with traders reporting demand from hedge funds to buy bets on a drop to $1.45 in three months.
Additional reporting by Anirban Nag; Editing by Toby Chopra