Sterling retreated on Friday after initially strengthening, as some investors still expected an interest rate cut next week even though business surveys pointed to a post-election bounce in the British economy.

Analysts said the pound had weakened because traders were taking profits on recent gains in the currency, and because money markets still priced in a 50% chance of a rate cut when the Bank of England meets next Thursday.

The 'flash' early readings of the IHS Markit/CIPS UK Purchasing Managers' Index (PMI) showed Britain's vast services sector returned to growth in January for the first time since August, while a downturn in manufacturing eased.

The release was widely anticipated after several BoE policymakers said earlier this month that they would vote for a cut to rates if Britain's economy did not soon show a marked improvement.

That knocked the pound last week, but this week it recovered as a series of business surveys suggested the UK economy could be picking up.

"Expect $GBP traders to profit take on PMI beat. Trade was picking the post dovish BoE comms low last week. Time to de-risk ahead of BoE event next week. MPC won't cut in Jan on this data (new orders up sharply)," Viraj Patel, an analyst at Arkera said.

The composite PMI, which combines manufacturing and services indexes, rose to 52.4 from 49.3, the highest reading since September 2018 and breaking beyond the 50 mark which indicates activity is growing. It easily beat the 50.6 consensus forecast in a Reuters poll of economists.

The services PMI rose in January to 52.9 from 50.0, also its highest level since September 2018 and well above the consensus forecast in a Reuters poll of 51.0.

Sterling jumped to as high as $1.3180 immediately after the surveys were released before falling back. It was last down 0.2% at $1.3098.

It also erased its initial gains versus the euro, and traded flat on the day at 84.255 pence.

Money markets currently assign a 50% probability of a rate cut next week, down from a high of 70% on Monday.

Economists at Jefferies said that with UK investment having flatlined since the 2016 Brexit referendum while investment had grown in Europe, there was clearly "pent-up demand" for investment.

That made a BoE rate rise more likely than a rate cut.

"Moreover, there is a fiscal expansion coming down the pipe in the (Britain's) Budget on 11 March, with potentially a significant regional dimension," they wrote.

"Depending on the scale of the fiscal easing announced...this could also significantly tilt the monetary policy debate later in the year," they said.