A stunning sterling rally is about to collide with Britain's political realities

LONDON — The British pound has jumped to its highest level in two-and-a-half years following a hawkish rate hold from the Bank of England, but strategists warn the upcoming U.K. budget could pose a risk to investor and consumer sentiment.

Many investors are awaiting the new Labour government's fiscal plan at the end of October before making longer-term calls on the U.K. economy and assets, with Prime Minister Keir Starmer warning decisions lie ahead that will be "painful" for the public to shoulder.

Labour, meanwhile, kicks off its annual party conference on Monday, its first in power for 15 years, as its leadership seeks to push past a recent controversy over donations and pledge to "rebuild Britain."

The Band of England held rates as the Fed cut them last week. Both actions were expected, but the former struck a surprisingly hawkish tone as it stressed the need for "gradual" easing, while the latter opted for a hefty 50 basis point reduction, as it emphasized the need to support the U.S. labor market.

Sterling breached $1.33 against the greenback for the first time since March 2022 on Thursday, and was trading at $1.3315 early London time Monday.

The pound's rally was tied to the BOE communication and "looks fully justified," Chris Turner, global head of markets at ING, said in a Friday note. Higher rates are traditionally a positive for a domestic currency as the higher yield can attract more foreign capital.

"The BOE does genuinely seem to be questioning whether inflation will come down as much as elsewhere in the world ... [the BOE] certainly does not seem to be in the Fed camp of signaling the 'all-clear' on inflation," Turner said.

Key concerns for the U.K. central bank remain services inflation – which rose to 5.6% from