Britain's political realities are set to clash with a remarkable sterling rally.

• In two and a half years, the value of the British pound relative to the U.S. dollar has reached its peak.
• The Labour Party's annual conference begins on Monday, marking its first time in power in 15 years. Amidst a recent controversy over donations, the leadership aims to move forward and fulfill its promise to "rebuild Britain."
• The U.K.'s economic growth is a top priority for Labour, as it has been repeatedly emphasized.

The pound has reached its highest level in two-and-a-half years after the Bank of England maintained a hawkish rate hold, but strategists caution that the upcoming U.K. budget may negatively impact investor and consumer sentiment.

The new Labour government's fiscal plan, which will be unveiled at the end of October, is eagerly anticipated by many investors as they wait to make informed decisions about the U.K. economy and assets. Prime Minister Keir Starmer has cautioned that the choices that will be made may result in "painful" consequences for the public.

The Labour Party begins its annual conference on Monday, marking its first time in power in 15 years, with its leadership aiming to move past a recent controversy over donations and commit to "rebuilding Britain."

The Band of England and the Fed both cut rates last week, with the former taking a hawkish stance and the latter opting for a 50 basis point reduction.

On Thursday, the pound breached $1.33 against the dollar for the first time since March 2022, and was trading at $1.3315 early London time Monday.

The pound's rally was justified due to the BOE communication, according to Chris Turner, global head of markets at ING, who stated in a Friday note that higher rates attract more foreign capital.

The BOE appears to be uncertain about whether inflation will decrease as much as other countries, while the Fed seems to be signaling that inflation is under control.

The main worries for the Bank of England are rising inflation, which increased from 5.2% to 5.6% in August, and annual wage growth that is still above 5%.

The positive outlook for the U.K. was attributed to the landslide election victory of Labour in July, which led to increased political stability, plans to reform housing policy, and strengthen ties with the European Union.

The warning is that the recent increase in the pound's value due to interest rate disparities could be threatened by the upcoming budget, which will be presented on October 30th.

If tax hikes erode the tentative improvement in U.K. investor confidence, the fiscal plan could be a test for GBP bulls, according to Jane Foley, head of FX strategy at Rabobank London, who shared this view via email to CNBC.

The government has ruled out hikes to value-added tax, national insurance, and income tax, but other tax increases, a crackdown on the ultra-wealthy, and public spending cuts may be implemented.

The U.K.'s economic growth is a top priority for Labour, as it has been repeatedly emphasized.

"Sterling was supported by a 1% increase in U.K. retail sales growth in August, but Turner cautioned that consumer confidence is declining, as indicated by leading indicators," he stated.

That in turn could have an impact on consumer spending and short-term growth.

Mixed outlook

The BOE is expected to gain more confidence in the U.K.'s inflation trajectory later in the year, which could lead to accelerated rate reductions after the November cut that markets have priced in.

Turner stated that it might take some time, but in the meantime, sterling can perform well, possibly pushing towards the $1.35 region.

Huw van Steenis, vice chair of Oliver Wyman, stated on CNBC's "Squawk Box Europe" on Friday that policymakers will closely monitor Labour's "bumper" pay increases, despite Bank of England Governor Andrew Bailey's assertion that public sector pay rises are not a significant contributor to inflation.

The new Labour government in the U.K. has announced that millions of public sector workers, including teachers and doctors, will receive above-inflation pay rises.

U.K. banks were hoping to maintain flat costs next year, but they're becoming anxious about having to increase them, according to him.

Gradualism is emphasized in the BOE statement, indicating that they are digging in and want it to be highlighted.