LONDON (Reuters) - Some of the world’s biggest investors are betting on a sustained recovery in the pound, confident that Britain will avoid a disorderly crash out of the European Union and that the Bank of England will hike interest rates more than previously expected.

UK pound coins plunge into water in this illustration picture, October 26, 2017. REUTERS/Dado Ruvic/Illustration

Bets on the pound, built up over the last few months, mark a sharp reversal in sentiment towards the currency from even a few months ago. Then, the risk of a “hard Brexit” under which Britain retains no preferential access to the EU’s single market, and the weaker performance of the UK economy, dominated headlines.

Wagering on the pound to continue the slide that followed the June 2016 referendum vote to leave the EU proved painful for hedge funds last year. The currency’s rally in recent months has forced many to unwind such positions and others to buy into the recovery.

On Thursday, trade-weighted sterling shot to levels not seen since the days after the Brexit vote, while at more than $1.43 the pound is on track for its best month against the dollar since 2009.

BlackRock BLK.N, the world's biggest investment manager, has raised a long sterling position by five times over the past year, to around 2.5 percent of an $11.7 billion fund.

Investors such as State Street STT.N have also bought sterling in recent months.

“We thought a lot of bad news was priced in for sterling and the downside risks were asymmetrically priced. Over the past few months we have significantly increased our position,” said Marilyn Watson, head of the global fundamental bond product strategy team at BlackRock.

“When you look at the UK economy, it is on a lower trajectory than what it was before but still healthy. The market is pricing one hike but I think they can hike a couple of more times,” Watson told Reuters in a telephone interview.

The slump in the pound in 2016 came to symbolise the economic loss that many predict Britain’s departure from the EU will trigger. While exporters have benefited, Britons travelling abroad have seen their cash squeezed and UK inflation has topped 3 percent.

“We are long sterling in our long term strategies as we think the undervaluation has room to correct,” said James Binny, global head of currency at State Street Global Advisors in London, adding that the asset manager had raised its sterling holdings in the last few months.

“While Brexit concerns remain in the short term, we think sterling is still undervalued despite the recent run.”

(For a graphic showing Sterling Trade Weighted Index, click here: reut.rs/2E94yOs)

But many investors warn that uncertainty over the shape of Britain’s future relationship with the EU is making them cautious about the rally.

UBS Wealth Management lifted its three-month sterling/dollar forecast to $1.40 from $1.36 this week, while keeping the 12-month forecast at $1.36.

G10 UNDERPERFORMANCE

The pound’s performance also reflects a broad sell-off in the dollar, now languishing at a three-year low against the euro, rather than improvements in Britain’s prospects alone.

The pound has gained a fifth from a 2017 low below $1.20 last January but is still some way off a pre-Brexit-vote high of around $1.50.

Against the euro, perhaps a better barometer of Brexit-related risk, it strengthened this week below 87 pence, its highest since June but still far below the sub-80 pence levels of before the vote to leave.

Roger Hallam, currency CIO at JP Morgan Asset Management, said he was, on balance, short sterling against the euro ahead of months of “challenging negotiations” with the EU.

Tepid British indicators point to an economy that is struggling despite a global boom, with the International Monetary Fund predicting 2018 growth of 1.5 percent, less than half the global rate.

“There is no question that the UK economic data is underperforming the G10. I don’t attribute sterling strength to the data,” said Kamakshya Trivedi, Goldman Sachs’ co-head of Foreign Exchange and Emerging Market Strategy, describing the views of the bank’s clients on sterling positioning as “split”.

Confidence remains high over the short-term, with futures data showing net long positions in the pound held by hedge funds and other speculators at a 3-1/2 year high. But longer-term investors such as central banks have barely budged, retaining a more cautious view.

Jane Foley, strategist at Rabobank, said the bank was getting calls from clients asking for upside protection against the pound in the derivatives markets, indicating investors have been taken by surprise by the recent rally.

That is a far cry from requests for hedges against further falls following the Brexit vote.

(For a graphic showing Sterling positions, click here: reut.rs/2DBTybi)

BOE TO SURPRISE?

Negotiations between Brussels and London have dominated sterling trading since 2016 but expectations for a transition deal to smooth Britain’s exit have risen recently.

The reduced risk of a disorderly Brexit has pushed investors to focus on the performance of the UK economy and monetary policy, both of which appear to be on a slightly firmer footing as evident from employment and wages data this week.

(For a graphic showing Sterling Employment data, click here: reut.rs/2E9JC9N)

Even some investors who are bullish on the UK see betting solely on the currency as too risky, however.

Alliance Bernstein senior portfolio manager John Taylor said he expected the BoE to raise rates twice this year from the current 0.5 percent, against the market consensus of one 25 basis point hike and for government bond prices to fall.

“It is a cleaner way to play the higher interest rate story via the bonds side as the currency could get affected by Brexit headlines,” he said.