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By Jemima Kelly
LONDON, June 28 (Reuters) - Sterling surged to a three-week high and Britain's FTSE 100 stock index fell on Wednesday, after Bank of England Governor Mark Carney said an interest rate rise was probably necessary and the bank would debate this "in the coming months".
The pound jumped by well over a cent after Carney's comments to hit $1.2971, its strongest since June 9, the day of the results of Britain's parliamentary election. That left it up 1.2 percent on the day.
Speaking at a European Central Bank conference in Portugal, Carney said policymakers would need to look at the extent to which stronger business investment offset a slowdown in consumption, as well as growth in wages and labour costs.
The remarks showed a shift in emphasis since a speech last week when Carney said now was not the time to raise rates. He did not repeat that phrase on Wednesday, and markets immediately priced in a greater chance of an earlier-than-expected rise.
Short sterling interest rate futures plunged, particularly across the mid-2018 to 2019 contracts, indicating a steeper path of interest rate hikes.
"Our main message would be not to over-interpret the comments – there’s definitely a disconnect when you look at what’s happening in the rates market and the way the FX market is moving," ING currency strategist Viraj Patel said.
"There is a risk that the moves are a bit too aggressive relative to what the central banks are trying to tell us. In the case of the UK, this withdrawal of stimulus could just be one rate hike and not the start of a full-blown hiking cycle. So you’ve got to be careful about overshoots in these currencies."
Having touched a seven-month low against a resurgent euro, sterling jumped 0.9 percent to 87.71 pence.
The euro jumped on Tuesday after European Central Bank President Mario Draghi hinted that the days of the bank's stimulus programme were numbered.
Britain's exporter-heavy FTSE 100 stock index, which tends to move inversely to the pound, extended losses to trade 0.4 percent lower, while mid caps were down 0.2 percent.
"Upside (in sterling) may be capped in the near term as Mr Carney has not signalled that the Bank is ready to tighten, only that there is an active debate taking place within the MPC (BoE Monetary Policy Committee)," ETX Capital analyst Neil Wilson said.
"Nevertheless, this was the most explicit signal that we are close to reaching the point at which a hike would be warranted."
Long gilt futures were last down 109 ticks on the day at 126.39, the biggest drop since Jan. 3 when inflation worries hammered British debt prices.
The two-year gilt yield touched its highest level since late October at 0.329 percent, up about 6 basis points on the day. (Additional reporting by Andy Bruce, Kit Rees and Ritvik Carvalho; Editing by Louise Ireland)