By Tom Wilson
LONDON (Reuters) - Sterling climbed against the dollar on Wednesday as UK inflation rose more than expected to its highest in almost three years, stoking speculation the Bank of England will have to consider sooner whether to reduce its massive stimulus programme.
Inflation jumped in June further above the BoE's 2% target to hit 2.5%, its highest since August 2018. Higher prices for food, fuel and used cars as the economy bounced back from its lockdown slump were among the drivers.
In response, the pound gained 0.5% to $1.3889, extending gains through the morning.
By 1325 GMT, it was at $1.38785, having clawed back the ground lost a day earlier in its biggest one-day drop for a month when the highest U.S. inflation in 13 years buoyed the dollar.
Against the euro, sterling gained 0.2% to 85.13 pence.
"Sterling higher is the right move," said Adam Cole, chief currency strategist at RBC Capital Markets. "The big test" for sterling would be any signals from the BoE next month on its readiness to normalise policy, he added.
The BoE has said inflation will peak above 3% before falling back. Some market players predict that the economic benefits of Britain's emergence from coronavirus lockdowns would in time lead to tighter policy.
"It's for how long inflation will remain above target that really matters," said Hugh Gimber, global market strategist at J.P. Morgan Asset Management.
"With growth rebounding impressively and inflation hotting up, the Bank will likely feel that the time is rapidly approaching to dial down the level of support they are providing to the economy."
Still, others analysts pointed to the headwinds on the British economy likely to come from the removal of stimulus measures such as a cut to stamp duty and the end of the furlough scheme for workers.
"The currently high inflation should not necessarily point to imminent BoE tightening as CPI pressures are to calm down in 2022," ING analysts wrote in a note.
"This means a limited positive spillover into GBP today."
(Reporting by Tom Wilson; Editing by Nick Macfie and Andrea Ricci)