The pound extended gains against its main rivals on Tuesday (13 December), climbing above $1.27 and briefly edging over €1.20, despite official data showing UK inflation rose to its highest level in over two years.

Sterling had climbed above $1.26 in the first session of the week and continued in the same fashion on Tuesday, edging 0.29% higher to $1.2710 and gaining 0.50% against the euro to €1.1978, after briefly breaking the €1.20 threshold earlier in the day.

The UK currency did not relinquish its gains even after the office for National Statistics said inflation, as measured by the Consumer Prices Index, came in at 1.2% in November, up from 0.9% in October. The figure was the highest rate on record since October 2014, when it stood at 1.3%. A break-up of ONS figures suggest much of the monthly rise was driven by increases in the cost of fuel, clothing, restaurants and hotels.

"While a stable rise in inflation is typically caused by healthy economic growth, in this situation inflation in the UK has been fuelled by the Pound's depreciation and rising oil which could be a cause for concern," said FXTM research analyst Lukman Otunuga.

"Although inflation continues to slowly edge towards the Bank of England's golden 2% target, this most likely will not be enough to persuade the central bank to raise UK interest rates at its policy meeting on Thursday."

Andrew Sentance, senior economic adviser at PwC, warned that more inflation was on the way. "We should therefore expect inflation to rise to close to 3% by the end of next year, which will squeeze consumer spending and slow economic growth," he added. "We are leaving behind the very favourable world of near-zero inflation which has benefited consumers over the past couple of years."

Elsewhere, the euro was on the back foot against the dollar, losing 0.24% against the greenback to $1.0609, which also gained 0.22% against the yen to ¥115.27. The US currency, however, was largely unchanged against its other major rivals, trading at CAD$1.3123 and AUD$1.3343 as investors focused on the upcoming Federal Reserve meeting, during which the US central bank is expected to raise interest rates for the first time in 12 months.

Craig Erlam, senior market analyst at Oanda, suggested that while the rate hike is all but certain, the economic forecast delivered by Fed chairwoman Janet Yellen will be even more closely monitored than usual.

"Given that a rate hike tomorrow is almost entirely priced in, the Fed's projections and dot plot combined with Yellen's comments in the press conference could be crucial in determining whether the Santa rally makes it to the New Year," he said.

"Investors haven't been easily spooked recently but the prospect of three or four rate hikes next year may be enough to do it."