"We're quite optimistic on sterling," said David Bloom, a currency strategist at HSBC Markets. Central bank policy-makers "have made the right policy choices. We remain reasonably confident about the UK economy".
On Friday, the pound was little changed against the euro at 0.6892. It touched 0.6855 at one point, its strongest since the euro's inception. It was also little changed against the dollar at $1.6391.
Economists said the Bank of England's quarterly inflation report, due to be released on Wednesday, would probably boost the prospect of further rate cuts in coming months. The Bank of England has cut official interest rates by a total of 2 percentage points since October, taking them to 5.5 per cent. The Bank of England said last week's larger than expected cut was needed to avert the possibility of deflation, given "the prospects for international activity and prices, domestic costs and consumer demand".
Michael Hume, the UK economist at Lehman Brothers International and one of the few analysts who correctly forecast the bank's cut of 50 basis points, predicted that more reductions were on the way. He said Wednesday's report will show that inflation, measured by the rise in prices minus mortgage interest payments, will undershoot the government's 2.5 percent target. "We're looking for inflation to be below the government's target for most of this year and next," said Mr Hume. "There are probably more rates cuts on the way to prevent inflation falling below target too much."
The outlook for even lower rates is reflected in the interest-rate futures market. The implied yield on the June contract stands at 5.11 per cent, far enough below current three-month lending rates of 5.78 per cent to suggest that traders expect at least 50 basis points off rates before June.
"We're getting to the point where rate cuts are not necessarily negative for sterling," said James Shugg, economist at Westpac Banking. He said that even though the interest rate differential was coming down, the bank's cuts would eventually feed through to a better economic outlook. "That's a positive for the pound."
In Europe, ECB policy makers left the benchmark refinancing rate for the 11 countries that adopted the euro unchanged at 3 per cent. A change had not been expected. Still, many economists see a cut by the end of the first quarter and predict rates will fall in the second quarter, undermining returns on euro deposits.
"Interest rates will need to be cut with slowing growth and low inflation," said Adam Chester, a treasury economist at Halifax. Even so with the European currency down more than 3 per cent against the pound and the dollar since its launch, he said "they don't want to exacerbate the euro's weakness," which could put it off until after the first quarter.
In New York, the dollar rose against the yen to 113.04 on expectations that Japan will try to drive down bond yields. "Lower yields are generally bad for a currency, especially when they are already about 2 per cent lower than anywhere else in the world," said Malcolm Gilroy at Laketon Investment Management in Toronto.