Sterling weakened against the euro on Tuesday after UK inflation dropped below the Bank of England's target for the first time in more than four years, easing pressure on the central bank to raise interest rates. The euro, which hit a one-year low against the pound on Monday, rose 0.4 percent to 82.34 pence, putting it on course for its biggest daily gain in two weeks.
The pound initially fell against the dollar from the four-year high it reached on Monday, dropping as low as $1.6655. Weak US data later helped it to recover to trade flat at $1.6713. UK consumer prices rose 1.9 percent on the year in January, slowing from December's rate of 2.0 percent. Economists taking part in a Reuters poll had expected inflation to stay at 2.0 percent.
Sterling, which faces Bank of England minutes and unemployment data on Wednesday, has been buoyant since the Bank of England last week raised its forecast for economic growth this year to 3.4 percent from 2.8 percent. It also said in its quarterly inflation report that market pricing calling for the first tightening of policy in five years in the second quarter of next year were consistent with keeping inflation on target.
"It (the CPI data) gives the Bank of England a little bit more cover to hold to a mid-2015 tightening schedule," said Paul Robson, strategist with RBS in London. "It makes the market less comfortable bringing forward a rate hike." Robson said he expected the pound to hit $1.69 by end of the first quarter, although he added that "anything in the $1.70s would be quite a stretch for sterling". Kathleen Brooks, research director at Forex.com, said the pound would have to fall below $1.6450 to negate the current trend higher. Sterling overnight interbank rates are pricing in a chance of a rate hike in 15 months' time, although this is a lower chance than was priced in at the end of last week.
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