By Harry Robertson
LONDON (Reuters) -The pound fell to a three-week low on Tuesday as investors digested economic data and looked towards an uncertain Bank of England interest rate decision on Thursday.
Sterling has risen around 6% this year as the BoE has hiked interest rates to deal with stubbornly high inflation, and as the dollar has slipped as U.S. price pressures have cooled.
It peaked at a 15-month high of $1.314 in the middle of July before falling after data showed British inflation came in lower than expected at 7.9% in June.
The pound was down 0.54% to $1.277 on Tuesday, the lowest since July 10.
Meanwhile, the euro was up 0.24% against the pound at 85.86 pence.
"Sterling’s decline isn’t out of lockstep with the general grind lower in G10 FX today against the dollar," said Simon Harvey, head of foreign exchange (FX) analysis at Monex.
"It seems as if markets are just taking a bit of risk off of the board ahead of key U.S. earnings and the Bank of England decision on Thursday, and Friday’s (U.S.) payrolls report, all of which pose credible risks of derailing the prevailing risk rally."
{{2126|The dodollar index - which tracks the currency against six peers - was up 0.44% at 102.35 on Tuesday.
Chris Turner, head of markets at ING, said weak global manufacturing data, driven by China's faltering economy, was weighing on sentiment and boosting the safe-haven dollar.
Survey results released on Tuesday showed that British factory output fell at the fastest pace in seven months in July, part of a trend around the world.
Separate data from mortgage lender Nationwide showed that British house prices dropped by the most since 2009 in the 12 months to July as rising interest rates took a toll on the market.
Traders think there is a 62% chance that the BoE hikes interest rates by 25 basis points this week, which would take them to 5.25%.
They see a 38% chance of a bigger 50 bp hike, according to pricing in derivatives markets.
"With inflation falling, house prices falling and economic sentiment gloomy, a 25 bp hike with a warning there could yet be more to come would seem sensible," said Kit Juckes, chief global FX strategist at Societe Generale (EPA:SOGN), in a note to clients.
"But given where expectations are that leaves GBP vulnerable this week. 25bp from the Bank, and solid US data, could easily drag GBP/USD back below $1.25.
Market pricing shows investors expect the BoE to lift rates to around 5.8% by early 2024. That's down sharply from early July when rates were expected to rise to 6.4% or higher.