"The economy isn't in as bad a shape as the market believes," said Jeff Woodruff, a currency strategist at BankBoston. The central bank's recent rate cuts "will ensure that the UK will not follow Euroland down the slippery slope of deflation and recession".
On Friday, the pound was little changed at $1.6083. Last week it gained 0.3 per cent against the dollar, though it is down 3.1 per cent this year.
The pound gained against the euro, pushing the European Union's single currency as low as pounds 0.6707, its lowest level since it was introduced on 1 January. The euro was down 1.8 per cent last week and 4.1 pe rcent since its inception.
The Budget, due to be released by Chancellor of the Exchequer, Gordon Brown, on Wednesday, is expected to show a surplus that the Government could use to increase spending on health and education. The Government said it wants to enhance school and health service standards, "and in order to do that, you need a large increase in spending", said Michael Hume, an economist at Lehman Brothers. "The Chancellor needs to assess whether his current spending plans can accomplish that."
More government spending without a deficit could help steer the country free of recession and lessen the need for more interest rate reductions, economists said.
Bank of England policy makers lowered their benchmark rate by 200 basis points in five reductions from October to February, leaving the rate at 5.5 per cent at their meeting last week. Further cuts would make deposits denominated in the pound less appealing, so the pound is likely to benefit from any signs the bank will stand pat. "We think sterling will hold at $1.60, with the prospect of it trading higher if the data confirms the economy is not slipping into recession," BankBoston's Mr Woodruff said.
A report due on Monday is expected to show that UK manufacturing declined at a slower pace in January than in December, a sign that the manufacturing recession may be ending. Output probably fell 0.2 per cent in January after declining 0.6 per cent in December, according to economists surveyed by Bloomberg News. The case for steady rates was also bolstered by reports showing increasing confidence among British retailers and falling unemployment.
A survey released last week by the Confederation of British Industry showed that confidence among retailers recovered from a near 19-year low in February. A report last month showed a surprise drop in the number of people out of work.
Still, the pound's gains may be tempered by speculation that the Bank of England could lower its base rate later in the year amid signs that UK inflation remains benign, and in an effort to keep the pound from rising too much. "UK rates could fall substantially," declining as low as 4.5 per cent by the end of the year, said Rob Minikin, a currency strategist at Citibank.
More confirmation of tame inflation could come from another report due on Monday. This could show that the prices charged by manufacturers declined in February. Producer prices probably fell 0.1 per cent in February after a 0.1 per cent gain in January, according to economists surveyed by Bloomberg News.