"The economy is in reasonably good shape," said Stephen Hannah, director of research at IBJ International. "Since the Bank of England appears to be trigger happy, we won't be foolish enough to rule out [rate increases of as much as 50 basis points in the next six months and further pound strength]".
The pound gained 2.5 per cent against the euro last week, rising to its highest level in three months on the evidence of economic resurgence and the surprise MPC rate rise. The euro was trading at pounds 0.6450 on Friday.
The pound also rose 1 per cent against the dollar, climbing to a four- month high, and was at $1.6180 on Friday.
The pound could rise to $1.6400 in the next three months, according to economists at the Bank of Tokyo-Mitsubishi. With more rate rises by the central bank "possible before the end of the year, the interest rate structure will remain substantially higher in the UK than in the euro zone," said Derek Halpenny, an economist at the bank. He added: "The prospect of accelerating economic activity in the UK while the US slows, should cause the pound to outperform the dollar."
Economists are now looking to this week's inflation report for signs as to whether inflation is speeding up. Reports on producer prices, unemployment, wage costs and retail sales will also be released.
The underlying rate of inflation, which is the BoE's target measure, is expected to have risen to an annual 2.3 per cent from 2.2 per cent in July, still below the Government's 2.5 per cent target.
Separate figures are expected to show that the August unemployment rate held at its lowest level in 19 years as the number of people out of work is estimated to have fallen by 10,000. Producer prices are expected to be little changed.
Some economists aren't so sure rates will have gone up by the year end. "Inflation remains clearly below the target, while the economy is still in the recovery stage," said Michael Klawitter, a strategist at WestLB.
In New York, the dollar rose to a seven-week high against the euro after a report on producer prices in the US that is likely to convince investors to favour US assets over European securities. It also makes it less likely that the Federal Reserve will raise interest rates when it next meets on 5 October. The Fed has raised rates twice since June to keep inflation in check. The dollar rose as high as $1.0380 per euro.
Against the yen, the dollar was trading at Y109.08 on Friday, up from a three-year low of Y108.06 on Thursday. This came after the Bank of Japan stepped in to sell yen for the first time since 21 July.
Some traders said that repeated interventions will be necessary to weaken the Japanese currency. Over the week, the dollar gained 2.1 per cent against the euro and shed 0.9 per cent against the yen.