"The Bank of England has been trimming interest rates fairly aggressively," said Jeremy Stretch, a currency strategist at Natwest Global Financial Markets. The cuts "will have a lagged effect and prevent a downturn", he said. "We'll see sterling coming back over the short to medium term."
On Friday, the pound rose to $1.6295, from $1.6241 on Thursday, reducing its decline for the week to 0.2 per cent. It could rise to $1.63 this week and could rise as high as $1.67 by the end of the first quarter, analysts said. Sterling rose against the euro on Friday, putting the European Union's currency at pounds 0.6922, down from pounds 0.6952.
The central bank has lowered its benchmark rate to 5.5 per cent, from 7.5 per cent, since October. A spate of reports this week will determine if those cuts are enough to revive growth, or at least slow its decline. An inflation report is due on Tuesday, an unemployment report on Wednesday and a retail sales report on Thursday.
The pound "has found a floor for the time being", said Tony Norfield, the global head of treasury research at ABN Amro Bank. "Further progress either way will depend on UK data."
Retail price inflation is likely to have fallen to the Bank of England's 2.5 per cent inflation target in January, from December's 2.6 per cent rate. "We are looking for large discounts in core items like clothing, footwear and household goods," said Michael Hume, an economist at Lehman Brothers.
The pound got support from a report on Tuesday by the British Retail Consortium showing that sales at shops and supermarkets rose in January, for the first time in four months. Thursday's retail sales reading may bring more good news. Economists at NatWest are expecting the report to show a gain of 2 per cent over the previous month, Mr Stretch said.
"We see a hold [on interest rates[," said Tony Drewitt, who runs the sterling derivatives desk at Euro Brokers International. "The bank is likely to be conservative and see the effects of past cuts filter through the system," before cutting again. But lower rates are still expected later.
On Wednesday, the central bank said in a quarterly inflation report that the economy may grow between 0.5 per cent and 1 per cent this year, after growing 2.5 per cent in 1998. The bank had previously forecast 1 per cent growth in 1999.
Lower rates elsewhere could still make the pound an attractive investment even if UK rates fall. A three-month sterling deposit pays 5.44 per cent, while a euro deposit offers a return of 3.10 per cent.
French Finance Minister Dominique Strauss-Kahn said he sees room for a cut in European Central Bank interest rates, which would widen the gap with UK rates and may bolster the pound. "I think today, given the weak inflation, there could be place for lower rates," Mr Strauss-Kahn said on Thursday. "That doesn't necessarily mean that will happen."
The ECB sets interest rates for Germany, France, Italy, Spain, Portugal, the Netherlands, Belgium, Finland, Luxembourg, Ireland and Austria, all of which adopted the European single currency on 1 January. It left its benchmark refinancing rate at 3.0 per cent at its most recent meeting.