Sterling reached its strongest level against the euro in two-and-a-half years on Wednesday, buoyed by a relatively hawkish Bank of England (BoE) stance and political uncertainty in France and

Germany. However, it weakened against a strengthening U.S. dollar.

The euro fell to 82.35 pence, its lowest level since March 2022, before recovering slightly to trade at 82.50 pence. A further dip below the March 2022 low of 82.035 pence would mark the euro's weakest level against the pound since June 24, 2016—the day Britain voted to leave the European Union.

"There's growing speculation, even in the mainstream press, about whether euro-sterling could revisit pre-referendum levels," said Jane Foley, Head of FX Strategy at Rabobank.

"This perception that the European Central Bank (ECB) is more focused on growth challenges, coupled with political instability in France and Germany, is weighing on the euro," Foley added.

While the UK economy faces its own challenges, Foley noted that "at least there is a budget" in Britain, which contrasts with political uncertainty in the eurozone. The expectation that the BoE may be more cautious than the ECB is providing some support for sterling, she said.

The BoE is expected to keep interest rates unchanged next week and adopt a cautious stance in 2024. Markets currently anticipate three 25-basis-point rate cuts from the BoE by the end of next year.

In contrast, the ECB is expected to cut rates by 25 basis points during its meeting on Thursday, with analysts projecting further cuts at every meeting through the first half of 2025, and potentially beyond. Weak economic growth in the eurozone, particularly in its core economies, is driving the ECB's dovish outlook.

Political instability is also weighing on the euro. The collapse of French Prime Minister Michel Barnier's government last week has left France's 2025 budget in limbo. Ministers are now working on stopgap measures to extend 2024 spending limits until a new budget can be drafted. Meanwhile, Germany's governing coalition fell apart last month, adding to uncertainty.

Against the U.S. dollar, the pound faced headwinds, slipping 0.34% to $1.2728 as of Wednesday. The dollar strengthened broadly ahead of U.S. inflation data, which investors fear may come in higher than expected and disrupt predictions of a Federal Reserve rate cut this month.