LONDON (Reuters) - Sterling rose on Wednesday as investors who bet against the currency, having expected more support at the Bank of England for further asset purchases, were wrongfooted and forced to buy it back.
Minutes from the last BoE policy meeting showed policymakers were still split at 6-3 on further asset purchases.
The BoE 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.
But gains in the pound are likely to prove fleeting, given widespread speculation that finance minister George Osborne will later in the day present a budget that will change the remit of the BoE to give it more leeway to stimulate growth.
That could pave the way for more aggressive monetary easing, despite sticky inflation, when new governor Mark Carney takes over in July.
The budget is also likely to cut Britain's economic growth forecasts and crank up government borrowing targets.
Against the dollar, sterling rose to a session high of $1.5158 from around $1.5034, up 0.3 percent on the day. It was not far from a recent peak of $1.5177 reached on Friday, with traders reporting offers around $1.5180 and stop-loss orders above $1.52.
The euro fell to 85.28 pence from around 85.77 pence before the central bank minutes were released. That took it close to a five-week low of 85.055 pence struck on Tuesday on concerns the financial crisis in Cyprus could impact the broader euro zone.
"Clearly the wording of the minutes show some policymakers are worried about a sharp drop in sterling and we can see some pushback 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.
Saxo's Hardy said that if Osborne tweaked the BoE's remit, it could hurt sterling, but given many in the market are already expecting a change, it may not show a sharp decline.
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.
Part of the reason for more sterling weakness, especially against the dollar, is expectations that the U.S. Federal Reserve may stop its asset purchase programme later this year.
As it wraps its two-day meeting, the Fed is likely to keep its ultra-loose policy bias in place with chief Ben Bernanke emphasising slow progress on jobs growth. This could see some investors book profits on long dollar positions.
Analysts said that while problems in the euro zone could support the pound, given edgy investors look at it as a safe-haven currency in Europe, risk of a triple-dip recession in Britain and a central bank that could aggressively ease policy in coming months are likely to keep most investors away.
"The pound is likely to prove more sensitive to any announcements from (Osborne)... that he is set to consider or will alter the BoE's inflation target remit which will support the pound's weakening bias," said Lee Hardman, currency analyst at Bank of Tokyo Mitsubishi.
"The combination of weak growth and a perceived higher inflation tolerance has created a negative environment for the pound with the recent rebound more likely to prove only temporary."
Reporting by Anirban Nag; Editing by John Stonestreet