Oct. 30 (Bloomberg) -- The pound rose to a 26-year high against the dollar on speculation the Bank of England will keep interest rates at their highest since 2001 while the Federal Reserve will cut borrowing costs tomorrow.

U.K. central bank policy maker Kate Barker signaled the rate-setting committee isn't yet convinced that signs of a slowdown in Europe's second-biggest economy warrant a cut in the benchmark interest rate. Interest-rate futures imply 94 percent odds the Fed will reduce borrowing costs tomorrow.

``The market mindset is that the Fed will continue to cut rates, while in the euro zone and the U.K. there's no certainty in that respect,'' said Neil Mellor, a currency strategist at Bank of New York Mellon Corp. in London. ``All roads point south for the dollar.''

The pound advanced to $2.0684 as of 3:25 p.m. in London after trading at $2.0694, the highest since May 29, 1981. Analysts forecast the pound will trade at $2.03 by year-end, compared with the $2.06 predicted by the forwards market.

While the U.S. is suffering its worst housing slump in 16 years, the U.K. economy grew faster than economists forecast in the third quarter. British gross domestic product increased 0.8 percent, led by services from airlines to banks, according to a government report on Oct. 19.

The Bank of England has raised interest rates four times in the past year, to 5.75 percent. Policy makers considered a cut this month and then voted 8-1 for no change. One monetary policy committee member, David Blanchflower, voted in favor of a reduction to counter the jump in corporate credit costs that followed the U.S. subprime mortgage-market collapse.

No Change

U.K. policy makers will leave the rate unchanged following their two-day meeting that ends on Nov. 8, the median of 37 forecasts in a Bloomberg News survey shows.

``We are asking ourselves if things are so different from August, and do we actually have to cut rates?'' Barker was reported by the Guernsey Press and Star newspaper as saying in comments confirmed later by the central bank. The economy is in a slowdown rather than anything more serious, she said.

With the bank's rate increases, the pound has strengthened 8.6 percent against the dollar in the past year.

The Fed has cut rates once this year as the housing slump and credit-market turmoil threatened to curb economic growth. The bank will lower its key rate by 25 basis points again tomorrow, to 4.5 percent, futures trading shows.

The pound extended gains after a report showed U.S. consumer confidence fell more than forecast in October, a sign that Americans are growing concerned about falling real-estate values. Home prices in 20 U.S. metropolitan areas fell in August by the most in at least six years, a private survey for the S&P/Case-Shiller home-price index showed.

``Confidence is something that the Federal Reserve cannot ignore,'' Mellor said. ``It can really make the difference between a recovery and a recession next year.''

U.K. government bonds fell, with the yield on the 10-year gilt rising 2 basis points to 4.87 percent.

To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net

Last Updated: October 30, 2007 11:52 EDT