Sterling rose above $1.97 against the dollar and hit a two-week high against the euro on Thursday as investors continued to buy the currency following Wednesday's Bank of England inflation report.

The report signalled the BoE would cut interest rates only modestly in the next few months after the Monetary Policy Committee said inflation was likely to overshoot its 2 percent target if it eases as aggressively as the market had expected.

Investors increasingly expect the European Central Bank to start to easing monetary policy soon to counter growing downside risks to growth. French and German gross domestic product data on Thursday appeared to back this view up.

At 0915 GMT, sterling was up 0.35 percent against the dollar at $1.9700, having traded as high as $1.9721.

The euro steadied against the pound at 74.22 pence, after hitting a two-week low earlier at 74.03 pence.

"In its Inflation Report, the MPC signalled that market expectations of rate cuts are overdone, but that the Committee does, nevertheless, envisage perhaps two more rate cuts will be needed to keep inflation on target in the medium term," wrote Barclays Capital strategists in a note on Thursday.

As recently as last week traders had expected the BoE to cut rates by as much as 100 basis points this year. That would be on top of the 50 basis points of easing in recent months to 5.25 percent.

But now, futures markets are discounting a little over 75 basis points of cuts.

Strategists at Barclays Capital, however, are not so sure the BoE actions will be as hawkish as its rhetoric.

The risks are that rates will be cut sooner and by more than they expect. We continue to expect sterling to weaken in the coming months and to target $1.91 for the end of Q1."

Traders also awaited Federal Reserve chairman Ben Bernanke's testimony to Congress on the state of the U.S. economy at 1500 GMT.

"It's very possible (Bernanke) could be erring on the pessimistic side particularly on growth, undermining the dollar," said Paul Mackel, senior currency strategist at HSBC. "The market could just be nervous about trying to be too long the dollar going into Bernanke's speech this afternoon."

Sourced by Reuters.