The pound strengthened versus the dollar and euro on Wednesday as reports that the Federal Reserve might introduce liquidity-boosting measures prompted a muted return of risk appetite, supporting high-yielding currencies.

The pound, with interest rates at 5.5 percent -- the highest in the Group of Seven industrialised nations -- benefits from the carry trade where investors sell low-yielding currencies like the yen to fund purchases of higher yielding assets.

Risk appetite got a boost after a Fed source said the U.S. central bank was actively considering all of the tools available to address liquidity issues.

Some media reports said action from the Fed on liquidity could come within days, even as soon as Wednesday.

However, the pound's gains were limited as investors expect further rate cuts from the Bank of England.

"The Bank of England is also on an easing cycle so it (sterling) will continue to underperform European currencies," said Kamal Sharma, currency strategist at Bank of America.

At 0830 GMT, the pound was up 0.4 percent versus the dollar at $2.0423. The euro was down a quarter percent at 71.86 pence.

Investors will look to UK average earnings, and employment data at 0930 GMT.

"The market has priced in a lot of easing from the Bank of England so investors will look to the data to see if this is justified," said Bank of America's Sharma.

Source Supplied by Reuters.