Sterling edged up on Tuesday after data showed the pace of pay growth in Britain, closely watched by the Bank of England as it gauges how much higher to raise interest rates, accelerated again.
The yen was perched near seven-month highs as investors held their breath for a potential policy shift at the Bank of Japan (BOJ).
The pound rose 0.2% to $1.2218 after data showed wage growth picked up more pace in the three months to November, while employment rose by a faster-than-expected 27,000.
"The official data showing employment conditions have held up better than expected should be taken with a pinch of salt", said Simon Harvey, Head of FX Analysis at Monex Europe.
"The BoE is unlikely to count its chickens before theyve hatched".
BoE Governor Andrew Bailey said on Monday that a shortage of workers in the labour market posed a major risk to forecasts that inflation will fall from its current levels above 10%.
FX strategists at ING and Monex Europe said it is too early to dismiss the risk of another 50 basis point interest rate increase in February as the BoE is set to hike rates for the 10th consecutive time.
EYES ON BOJ
The yen steadied around 128.72, down 0.17% against the U.S. dollar after hitting a late May high of 127.22 per dollar on Monday. Options trade shows a market braced for sharp moves when the BOJ concludes a two-day meeting on Wednesday, with overnight implied volatility surging to a six-year high.
Speculation is building about a change or end to Japan's yield curve control policy, given that the market has pushed 10-year yields above a ceiling set by the BOJ of 0.5% and the amount of bond buying to defend it is becoming staggering.
A newspaper report last week has also stoked expectation for a change, so traders are on the lookout for a sharp reaction even if the BOJ makes no move.
"The market has run pretty hard with this story and is looking for a follow up," said Tony Sycamore, an analyst at brokerage IG Markets.
He sees three main possibilities: no policy change, a tweak similar to a move in December to widen the 10-year yield target band, and the total abandonment of yield curve control, with the latter likely to drive the most extreme market response.
Elsewhere, the U.S. dollar index has bounced from a seven-month low of 101.77 hit on Monday and held at 102.4, up 0.1%. The euro steadied at $1.0819.
There was not a great deal of currency market reaction to far stronger-than-expected Chinese growth data. The yuan last traded 0.6% weaker at 6.7760 per dollar.
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