LONDON Sterling surged more than 1 percent on Tuesday to its highest level in over three weeks, as some investors bet that rapidly accelerating inflation would push the Bank of England to raise interest rates sooner than expected.
Data released earlier in the day showed British inflation jumped in February above BoE's 2 percent target for the first time since the end of 2013, with consumer prices rising by a stronger-than-expected 2.3 percent.
Sterling jumped to as high as $1.2495 as investors brought forward their expectations for when the BoE would hike rates from their record lows.
One-year Sterling Overnight Index Average (SONIA) forwards -- which reflect investors' expectations for benchmark interest rates -- jumped to their highest since June 24, the day after Britain voted to leave the European Union.
BoE Governor Mark Carney said it was important not to overreact to a single month's data. Though one policymaker last month voted to hike rates, the outgoing Kristin Forbes, most BoE rate-setters have noted how slowly wages are growing, which would be a reason to keep rates low.
"I think there's a very misguided belief that we'll see the Bank of England hike interest rates any time soon," said Jeremy Cook, chief economist at payments company WorldFirst.
"Real wages are in negative territory. I think it would be very out of character for the BoE to hike interest rates at a time when the average consumer is getting poorer and the high street - by which the British economy almost lives and dies - is going to come under pressure."
Britain's unemployment rate fell unexpectedly to its lowest in more than a decade in the three months to January, but pay growth worsened, in an unpromising sign for the economy ahead of its divorce with the EU.
Sterling also climbed against a broadly stronger euro, up almost half a percent at 86.55 pence.
Many analysts say its movements over the coming two years will largely depend on Britain's negotiations with the EU as it exits the bloc.
Data last week showed short positions against sterling have reached a record high. [IMM/FX]
"We think most of the weakness is behind us and expect (sterling/dollar) to stabilise around current levels this year," wrote ABN Amro strategists in a note to clients. "A lot of bad news is already in the price."
(Editing by Julia Glover)