LONDON Dec 18 (Reuters) - Sterling jumped against the dollar and euro on Wednesday after UK unemployment fell by more than expected, raising expectations that interest rates could rise earlier than previously forecast.
In minutes of its latest meeting, the Bank of England expressed concern that a strong pound could hurt Britain's economic recovery.
The pound hit a session high of $1.6365, up 0.5 percent this session, after news that the unemployment rate had fallen to 7.4 percent in October, its lowest in four-and-a-half years. Analysts had expected the rate to remain at 7.6 percent.
The BoE said in its forward guidance in August that it would not consider raising rates until unemployment fell below 7 percent, something it expected to happen by the end of 2016. But last month it said unemployment could hit 7 percent as early as the fourth quarter of 2014.
After the data the sterling overnight interbank average rates moved higher to price in the chance of a rate hike in 18 months, compared with two years, before the data was released.
The euro fell 0.7 percent to 84.05 pence from 84.355 pence beforehand.
The pound was also supported as the CBI distributive trades survey's retail sales balance surged to +34 in December, matching September's 15-month high.
However, there was a note of caution as the Bank warned that Britain's economic recovery may be at risk if sterling, which hit a five-year high against a basket of currencies earlier this month, strengthens much further.
The Bank also said inflation could hit its 2 percent target for the first time in over four years early in 2014.
"The labour market data was very strong... Sterling is gaining on the back of that," said Ian Stannard, head of European currency strategy at Morgan Stanley.
"It's been through some key levels, which suggests it has some room to move. Given it's broken out of its ranges it could head to $1.6450 and 83.50 (pence per euro)."
However, he also highlighted the Bank's warning on sterling's strength and its comments on inflation as potentially dovish signals.
"It does look as if they're paying quite a bit of attention to sterling," he added. "I see this as a temporary move higher, particularly for cable." Cable is the exchange rate between the pound and the dollar.
March gilt futures erased gains to stand 26 ticks lower at 107.58. They were around 107.99 before the release.
"What it means is because of the momentum of the data generally in the UK ... it's going to keep the market and short sterling under pressure into the new year. The risk is that the market prices in earlier and earlier tightening," said Philip Tyson, strategist at ICAP.
Sterling has been one of the currency market's surprise packages this year, gaining 8.4 percent since early August as better-than-expected UK economic data has added weight to the view that interest rates may rise earlier than previously expected.
But it fell to a six-week trough versus the euro and a three-week low against the dollar on Tuesday after data showed UK annual inflation slowed in November to its lowest in four years, giving the Bank some breathing space to keep interest rates low to support the recovery.