By Tommy Wilkes
LONDON (Reuters) - Sterling jumped more than one cent against the dollar on Thursday after the Bank of England said interest rates probably needed to rise sooner and by a bit more than it had thought three months ago.
Interest rate futures <0#FSS:> now project a 60 percent chance of a BoE rate hike in June and fully price in an increase in August meeting.
Before the BoE announcement, in which the bank also raised its UK economic forecasts, markets had priced in a 50-50 chance of a rate hike by May.
The central bank's Monetary Policy Committee raised interest rates for the first time in a decade in November.
"This is a Brexit-contingent hawkish signal," said Viraj Patel, an FX analyst at ING in London.
"The comment in itself was the surprise. That was a clear message from the bank that the (interest rate) curve was a little too flat for their liking."
The pound rose as much as 1 percent to a day's high of $1.4028 <GBP=> after trading flat before the BoE announcement.
Against the euro, sterling rallied more than 1.2 percent, its best one-day performance in nearly five months, to a one-week high of 87.32 pence (EURGBP=).
Britain's internationally exposed FTSE 100 (FTSE) fell 1.1 percent to a session low after the BoE decision.
Sterling has been one of the best performing currencies this year, rising to its highest levels since before the June 2016 vote to leave the European Union, but the rally faltered in recent sessions.
TACKLING PRICE GROWTH
With rising inflation expectations globally, investors are predicting central banks might tighten policy faster. But the outlook for Britain has been overshadowed by the state of UK-EU talks for Britain's exit from the EU next year.
Governor Mark Carney and colleagues said they now wanted to return inflation to its 2 percent target over "a more conventional horizon", a sign they were turning their sights to tackling price growth over two years rather than three.
Neil Jones, head of hedge fund FX sales at Mizuho Bank, said inflationary worries were "somewhat unwarranted in the UK" - where sterling weakness has driven prices higher - and that further gains for sterling would be limited.
With the BoE's comments contingent on a smooth exit from the EU next year, analysts said sterling's performance also depended on the terms of Britain's Brexit transition deal.
Sterling rose to a 16-month high of $1.4346 in January before falling back. It remains up more than 3.4 percent against the dollar this year, but far below the plus-$1.50 levels where it traded before the vote to exit the EU.
In bond markets, British two-year government bond yields (GB2YT=RR) rose to the highest since December 2015, rising by around 6 basis points after the decision to 0.706 percent.
(Reporting Tommy Wilkes, Kit Rees and Andy Bruce, editing by Larry King)