In thin trading, sterling broke through the psychologically important $1.70 barrier to settle nearly two cents up at $1.71, a rate not seen since September 1992 after the UK was forced out of the European Monetary System. It was a similar story against the German mark, with the pound's half-pfennig rise to 2.6365 taking it above previous peaks reached over the last four years.
Analysts said the currency was being driven by hopes of a further interest rate rise in January. Expectations that money rates could go up later this month were fuelled by further signs of the continuing pick-up in the UK economy, with strong mortgage lending figures for November and what was described as "pretty robust" money supply data for the week before Christmas.
The British Bankers' Association said approvals for new lending had dipped by 6 per cent between October and November, half the rate recorded in the same period of last year. Meanwhile, gross lending actually made in the month at pounds 2.67bn was fractionally ahead of the already strong figure for October.
Analysts said foreign currency investors were being drawn to the UK as one of the only countries around the world where the trend in money costs is upwards. But they warned that the limited trading meant too much should not be read into the year-end exuberance.
Chris Turner of Barclays de Zoete Wedd said: "It is a very thin market and there is not much trading going on. Really it is just a continuation of what we have seen over the past week or so as people look forward to a rate rise early in the new year."
The recent weakness of the yen was a contributory factor, he said. Japanese investors were increasingly looking for higher returns outside Japan, according to Mr Turner, with the UK the only major country where an imminent rate rise is expected.
Robert Prior of HSBC James Capel said there was nothing particularly new yesterday, although the strong M0 and lending figures lent support to the interest rate story. Most people were discounting a rise in January, possibly after the next meeting between Bank of England Governor Eddie George and the Chancellor, Kenneth Clarke, on 15 January.
Equities shrugged aside the possible impact of a stronger pound on overseas earnings to notch up its fifth closing high of December. The near-12 per cent gain defied many sceptics at the beginning of 1996 who suggested the market would be largely unchanged during the year. But the near-12 per cent gain was well below the 20 per cent recorded the previous year and came nowhere near the record 35 per cent performance of 1989. And with only 203 million shares traded in a truncated half-day session which missed an early morning fall on Wall Street, the few dealers at their desks warned yesterday that the strong showing should not necessarily be taken as a pointer to next year's performance.
Robert Buckland of HSBC James Capel described the market as "very dull", with no real change in direction. "It is very difficult to find any signal or lead. There are not loads of fund managers saying, `This stock is very cheap' and others saying: `No they're not, have mine'." He is forecasting only a modest increase in the main index to 4,400 for this year.
Technical factors played their part in yesterday's rise, which came on the back of the expiry of so-called FTSE 100 index "flex options", which are dealt in over the counter.
The last set of economic statistics from the old year added to the warm sentiment yesterday. The 6 per cent fall in the number of new mortgages approved left a total of 40,259 for November, worth pounds 2,358m, but this was only half the seasonal fall recorded in November 1995. "This points to a general and sustainable strengthening of the whole market," according to Tim Sweeney the director-general of the BBA.
The BBA includes eight of the 20 biggest mortgage lenders and the complete mortgage figures due on Friday are expected to show the level of mortgage lending has accelerated steadily since April 1996 and is now running almost 5 per cent higher than a year ago.