By Laurence Fletcher
LONDON (Reuters) - Hedge funds are approaching Wednesday's Bank of England minutes betting the pound will extend its surge to a one-year high against the euro but wary the bank could signal interest rate rises may be pushed back.
Many hedge funds were slow to catch on to the pound's 12 percent rally from early July to the end of 2013. The gains came as the UK economy's recovery increased the chances the Bank would be the first major central bank to raise interest rates. As the rally took hold, funds added to their bets, ending the year bullish.
Since then, mixed data has seen the pound rise versus the euro but slip against the dollar as the U.S. Federal Reserve began to taper its bond-buying programme. Consumer price data fell last week to the Bank's 2 percent inflation target for the first time in four years, easing pressure to raise rates. Factory orders fell in January, although future orders were strong.
Some investors say Wednesday's minutes could hint at a lowering of the 7 percent unemployment threshold, at which the Bank has said it would consider rate rises.
Nevertheless, funds remain positive on sterling, although there are signs of caution.
"Sterling looks all right," said Paul Chappell, CIO of UK-based hedge fund firm C-View. "We're more optimistic about the pound than many other countries' (currencies)."
Chappell said he is long sterling versus the Swiss franc and the Canadian dollar
"The only reason to be cautious on sterling is that everyone likes it. It's a bit of a crowded trade," he said. "The longer this carries on, the more crowded the trade becomes, and the more we'll be inclined to slim down our exposures."
Leveraged funds' long positions on sterling are three times the size of their short positions, according to the U.S. Commodity Futures Trading Commission's Commitment of Traders (CoT) report.
However, Scotiabank strategists said there had been "a continued moderation in bullish sentiment toward ... GBP", with short bets in the CoT report rising at a greater percentage rate than long bets.
Computer-driven hedge funds have profited from a rising pound. According to the Newedge Trend Indicator - a model that replicates the trades computer-driven trend-following funds might make - funds have been long the pound for months.
Swiss-based Insch Capital's Kintillo fund is long the pound against the euro, Swiss franc, yen and dollar, although it has changed bets this month as the pound has drifted.
On Tuesday the pound rose 0.2 percent to $1.6467. The euro was 0.3 percent lower against sterling at 82.21 pence. It earlier hit a low of 82.145 pence.
British 10-year government bonds reversed early losses to rise slightly on the day. The spread over equivalent German bonds widened briefly to 110.2 basis points, its highest since January 6, before tightening again.
The pound has been underpinned by higher short-term market rates this week, after Friday's bumper retail sales number led markets to price in the possibility of a rise in interest rates in a year's time.
Wednesday also sees the release of UK unemployment data.
Valentin Marinov, head of European G10 FX strategy at Citibank, is more cautious than some about Wednesday's data, judging it unlikely to damage the outlook for the pound.
"The market and Citi economists are expecting another drop in the unemployment rate in November to bring it closer to BoE's 7 percent threshold," he said.
But he added the minutes may disappoint those looking for hints the Bank discussed changing the unemployment threshold.
(Additional reporting by Patrick Graham and Andy Bruce; Editing by Larry King)