Expectations grew that France and Germany will resolve differences over the inclusion of job creation measures in the "stability pact", designed to limit budget deficits after the planned introduction of a common currency in 1999. An accord should be reached in time for the European Union summit in Amsterdam.
Any delay in the timetable for European economic and monetary union would benefit the mark, as it would remain Europe's benchmark currency.
"Investors are anticipating a compromise on the stability pact and that clearly underpins the pound, which is out of the whole currency project," said Rob Hayward, an economic adviser at Bank of America.
The pound rose to 2.8368 marks, its highest since reaching 2.8420 marks on 3 August 1992. The pound also climbed against the dollar to $1.6405, after a surprise fall of 0.3 per cent in May US producer prices dampened expectations for a rise on official US interest rates when the Federal Reserve meets on 1-2 July.
The pound has benefited from uncertainty over EMU in recent days as Britain has not committed itself to joining the euro at the inception on 1 January 1999.
Concern that EMU may be delayed was fuelled after French Finance Minister, Dominique Strauss-Kahn, threatened to withhold France's approval until after the Amsterdam summit.
The pound was also underpinned by persistent expectations that base rates will rise in the coming months. Chancellor of the Exchequer, Gordon Brown, said on Thursday he changed the inflation target from "2.5 per cent or less" to 2.5 per cent. Economists said the new inflation target had the merit of being clearer.
Richard Iley, an economist at ABN AMRO Hoare Govett, noted that while Mr Brown's announcement implied "greater inflation tolerance" with retail prices now able to run in a 1.5 per cent to 3.5 per cent corridor, the newly independent Bank of England will still be keen to establish credibility.
The Bank of England has voiced its concern that strong domestic demand is likely to push prices higher next year and such concern was reinforced by manufacturing, industrial production and retail sales reports last week suggesting that the economy may be strong enough to warrant a rise in the months ahead to keep inflation in check.
Looking ahead, investors are awaiting the 2 July Budget. "While the market is confused about the implication of Brown's announcement implying a relaxation of monetary policy, the market is waiting for the content of the interim Budget," said Simon Briscoe, economist at Nikko Europe.
"The pound is likely to carry on swinging heavily in the coming days, until we get a clearer picture," he said. Copyright: IOS & BloombergReuse content