Profit-taking knocked sterling off earlier 26-year peak versus the dollar on Thursday, with soft UK housing data also weighing on sentiment. Data from the Royal Institution of Chartered Surveyors showed that house price inflation slowed sharply in June to its weakest in 1-1/2 years.
Although this did little to alter expectations of at least one more rate hike from the current 5.75 percent in the coming months, it gave some investors an excuse to book some profits on the recent sterling rally.
"The RICS numbers overnight weren't particularly encouraging. Cable (sterling/dollar) around $2.03 is more than fully valued, and people are maybe looking to book a bit of profit there as well," said Jeremy Stretch, currency strategist at Rabobank. By 1406 GMT, sterling was down 0.2 percent at $2.0285, having earlier scaled 26-year peaks of $2.0364.
A broadly strong euro was up 0.4 percent at 67.87 pence. While UK rates are seen rising, the Federal Reserve is expected to stay on hold at 5.25 percent and there are growing expectations that a cut may be on the cards if troubles in the US subprime mortgage market - which caters to borrowers with poor credit histories - spill over into the wider economy.
Prospects for a widening UK/US yield differential have boosted the pound. However, markets may be too hawkish on the UK rate outlook given some signs of a slowdown in the housing market and warnings from several UK firms that five Bank of England hikes in less than a year are taking their toll.
"I would imagine this is the start of a slightly more negative period for the housing market and if that does develop, it will start to raise some question marks about how extended this period of tightening will be," said Ian Gunner, head of foreign exchange research at Mellon Bank.
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