Hawkish comments from a member of the Bank of England's Monetary Policy Committee (MPC) coupled with a perceived weakening of the CBI's "the next move should be down" stance on rates re-awakened fears of an interest rate hike following next week's MPC meeting.
After a weak start, the pound gained almost a pfennig against the mark following a speech by Mervyn King, the Bank's chief economist and executive director, at the Building Societies annual conference.
Sterling finished the day at DM2.905, up from 2.898 on Tuesday.
Mr King, a "hawk" who voted for a rate rise at April's MPC meeting, said domestically generated inflation was "significantly higher than RPIX inflation [the measure of inflation targeted by the Government]". Mr King warned: "Inflation will start to rise above the target unless domestically generated inflation declines".
He added: "The earnings figures released earlier this month - which showed that average earnings in the economy grew by 4.9 per cent and in the private sector by no less than 5.6 per cent - were undoubtedly disappointing. To hit the inflation target those rates of earnings growth will have to fall back."
Mr King said that even though the MPC predicted a slowdown in the economy, it might not be sufficient in itself to hold back inflation.
Meanwhile, the Confederation of British Industry (CBI) indicated a slight softening over its stance on interest rates by warning that the country could not afford to trade "short-term gain for long-term pain".
Addressing the organisation's annual dinner in London last night, the CBI president Sir Colin Marshall called on the Government not to ease up in the fight against inflation.
He also gave a rare acknowledgement that the strong pound, while hurting manufacturers, exporters and inward investors, was also good news for importers, retailers and holidaymakers.
Speaking after the Prime Minister, Tony Blair, had addressed the dinner, Sir Colin said the CBI had been encouraged by the way the Government had seen eye to eye on the need for stability, sustainability and economic development.
But he added: "Central to our largely mutual philosophy is the need to combat and control inflation, ahead of almost all other economic considerations. "We simply cannot afford to trade short term gain for long-term pain."
Despite yesterday's developments, most City economists still believe the outcome will be "no change" after next week's two-day MPC meeting, which will start on Wednesday.Reuse content