Sterling weakened on Tuesday, most notably against the dollar, which got a boost after US manufacturing data suggested recent financial market turmoil may not be having as negative an impact on the US economy as some had feared.
The pound had suffered earlier in the day from unwinding of carry trades that use cheap borrowing in low-yield currencies such as the yen to pick up a yield spread by buying higher-yield currencies such as the pound and the New Zealand dollar.
Ongoing stress in lending conditions on the interbank money market kept the pound under selling pressure. But while it pared losses against the ultra low-yielding yen in the wake of the US Institute for Supply Management data, sterling remained soft against the dollar.
"Despite the latest UK economic data coming in on the strong side, cable remains vulnerable in the near-term to any further pick-up in risk aversion," said Ian Stannard, senior foreign exchange strategist at BNP Paribas. "It is taking its lead from equity markets. If risk appetite remains suppressed and this keeps carry trades under pressure, I would not be surprised about cable falling to the $1.9950 area."
At 1500 GMT the pound was down 0.4 percent versus the dollar to $2.0107, erasing a small part of earlier losses after European equities turned positive on the back of the ISM data.
The ISM manufacturing index slipped to 52.9 from 53.8 in July to almost meet analysts' forecast of 53.0, suggesting limited interruptions to business so far from credit and money market turmoil. The pound shed 0.2 percent versus the yen to 233.51 yen, also coming off earlier lows. The euro was up slightly against the pound at 67.56 pence.
London interbank rates for three-month sterling money hit a new 8-1/2 year high on Tuesday, while dollar rates for the same period rose again as banks rushed to secure cash to safeguard their funding requirements.
The market turbulence has prompted many investors to look for the Bank of England to hold interest rates at 5.75 percent on Thursday after five hikes since August last year, despite economic activity keeping up a strong pace of growth last month.
A survey on Tuesday showed growth in the British construction sector accelerated in August to its fastest rate in more than nine years, while the British Retail Consortium said retail sales picked up in August.
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