The pound surged to its highest level since March 2022, breaking through the $1.33 mark, after the Bank of England decided to keep interest rates steady at 5 per cent and signalled a gradual approach to monetary loosening.

Sterling rose by as much as 0.7 per cent against the dollar, hitting $1.331, following the Bank’s decision on Thursday. The currency also gained 0.3 per cent against the euro, reaching €1.19, its strongest level since July. The rise came as the US Federal Reserve delivered a larger-than-expected half-point rate cut earlier in the week.

High interest rates tend to bolster a currency’s value by attracting investors seeking better returns. Although the UK has slowed its cutting cycle compared to the US and the eurozone, traders expect only one more rate cut from the Bank of England in November, keeping the pound competitive. Nomura analysts have predicted that sterling could hit $1.35, a level not seen since January 2022.

Despite inflation falling to 2.2 per cent, near the Bank’s 2 per cent target, the Monetary Policy Committee (MPC) said it would remove policy restraint gradually, with inflation likely to rise to 2.5 per cent by year-end. The decision to pause rate cuts weighed on UK government bonds, driving 10-year gilt yields up by four basis points to 3.88 per cent.

Meanwhile, the FTSE 100 and FTSE 250 indices both rallied, closing up 0.9 per cent and 1.6 per cent, respectively.

However, Nick Andrews, senior FX strategist at HSBC, warned that sterling’s gains may be short-lived, predicting that the pound could weaken as the Bank may eventually have to cut rates more aggressively than currently anticipated. He added, “The outlook for the UK economy is likely to weaken relative to the US, which will weigh on the pound/dollar.”

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Pound reaches two-year high as Bank of England holds interest rates steady