Sterling fell against the euro on Tuesday on concerns the Bank of England would indicate a long period of lower rates in its Inflation Report, but robust industrial output data helped it rise versus the dollar.
The BoE will present its quarterly Inflation Report on Wednesday, having reiterated last week that it would provide an assessment on the use of thresholds and forward guidance, as requested by finance minister George Osborne.
Traders said many investors were betting the BoE's report would dampen UK interest rate expectations, despite a recent string of data pointing to an improving economy.
"People are just a bit reluctant to push sterling higher ahead of the Inflation Report tomorrow … we're likely to see some form of forward guidance, aimed at keeping market interest rates low," said Simon Smith, chief economist at FXPro.
Figures showing the fastest rise in UK industrial output in nearly 2-1/2 years, helped the pound rise 0.2 percent against the dollar to $1.5377. But gains were limited and it stayed pinned below $1.5435, the late July peak.
Sterling underperformed the euro, which was up 0.25 percent at 86.58 pence, recovering from a low of 86.185 pence hit after the UK data was released.
This will be the first Inflation Report presented by new BoE Governor Mark Carney.
Short-term interest rates are being anchored by expectations that the central bank may signal it will keep its key policy rate low at least until late 2015/2016.
Money market rates, such as overnight indexed swaps , are pricing in the possibility of the first move in the bank rate, currently at 0.5 percent, in three years. A 25 basis point rate hike is fully factored in only in four years.
"If they (the BoE) put explicit thresholds around forward guidance, or some sort of message similar to that, sterling would fall," said Saeed Amen, currency strategist at Nomura.
However, some analysts warned the BoE may be more upbeat in its outlook than the market is expecting. Kathleen Brooks, research director at FOREX.com, said recent improving UK data would make the BoE "more conservative in the forward guidance".
She said this could lift the pound towards $1.55 in the short term, while the euro could drop below 86 pence.
The UK industrial output data prompted the National Institute of Economic and Social Research to forecast the economy grew by 0.7 percent in the three months to July.
Data also showed solid rises in car sales, house prices and retail sales, pointing to a broad recovery.
