Higher interest rates would make the pound a better investment
The pound has risen to a four-month high against the euro, after higher than expected UK inflation raised the prospect of interest rate rises.
Currency analysts said the pound was also lifted by Kraft Foods' takeover of Cadbury highlighting the continuing attraction of investing in the UK.
Meanwhile, the euro was weakened by lower German business sentiment and continuing concern over Greece's debt.
The pound was up 1.3 cents to 1.1477 euros, making a euro worth 87 pence.
The rise in sterling came after UK inflation rose at its fastest annual pace for nine months in December.
Official figures showed that the Consumer Price Index measure of inflation hit 2.9% in December, up from 1.9% in November.
The December increase was above analyst expectations of a rise to 2.6%.
With UK inflation once again above the government's 2% target, currency investors seem to think it may mean the Bank of England considers raising interest rates from their record low of 0.5% to help bring it down again.
In a speech on Tuesday evening, Bank of England Governor Mervyn King warned that inflation was "likely to pick up markedly in the first half of this year".
He added that it was "likely to rise to over 3% for a while", and that it could go even higher if energy prices and indirect taxes were to increase further.
However, he said inflation "should return to target in the medium term".
Higher interest rates would lift the pound as it would make it a more lucrative investment for currency investors.
The increase in inflation may also mean the Bank of England chooses not extend its £200bn policy of injecting new money into the economy.
This initiative, formally known as quantitative easing (QE), is due to conclude next month, but the Bank has previously said it would keep the programme under review.
Critics of quantitative easing have long warned it may have an inflationary effect.