By Amanda Cooper
LONDON (Reuters) - The pound retreated on Monday but remained in sight of last week's 15-month highs against the dollar, with investors becoming more convinced the Bank of England will take a tough line on inflation by raising rates a lot more than expected.
The main data point for UK markets this week are wage growth figures on Tuesday, while investors will also be looking out for remarks from both Bank of England Governor Andrew Bailey and finance minister Jeremy Hunt, who will address the City of London's financial elite at an annual dinner later on Monday.
Last week, the pound gained 1.2% - its largest weekly gain since mid-June - thanks to a surge in British government bond yields, as investors reassessed their expectations for the economy and interest rates.
Sterling is the best performing currency among the G10 this year, having gained 5.8% against the dollar and 3.2% against the euro. But given the glum outlook for the economy, these gains may be harder to sustain in the longer run, analysts said.
"While the comparatively hawkish BoE has supported the pound, the economic outlook for the UK is under pressure and fears of a recession could limit further gains," City Index strategist Fiona Cincotta said. She said the "path of least resistance" for sterling for now is upwards, but last week's high could prove to be a hurdle to a longer rally.
"Buyers need to rise above $1.2850 to extend the bullish trend towards the $1.30 psychological level," she said.
On Monday, sterling was last down 0.4% against the dollar at $1.2789 and down 0.3% versus the euro at 85.69 pence.
Data on Tuesday will offer a snapshot of the labour market. Economists polled by Reuters expect the unemployment rate to have held steady at 3.8% in May, but the day's main event will be wage growth figures. Average earnings excluding bonuses are expected to have risen at an annual rate of 7.1% in the three months to May, down a touch from April's 7.2%.
"The question is whether that’s solely down to firms implementing the 10% increase in the National Living Wage, or a genuine increase in pay pressures. Assuming it’s at least partly the former, we think we could get a fractional fall in the annual rate of pay growth in the May reading," ING strategist Francesco Pesole said.
Interest-rate derivatives show traders expect UK rates to keep rising to a peak of near 6.5% by next May, with no cuts now expected for at least a few months after that.
In real terms, wage growth in Britain has been in negative territory since last November, while grocery inflation has run at 20% and rent now accounts for 28% of people's pre-tax earnings, according to recent data.
Adding to the pain of high food and energy prices, mortgage rates have climbed sharply in recent weeks as investors increased their bets on how high the BoE will raise interest rates to fight high inflation.
A key rate on Monday rose to within a whisker of last autumn's high after then-prime minister Liz Truss' "mini-budget", figures from data provider Moneyfacts showed on Monday.
Average two-year fixed rates stood at 6.63%, up from 6.54% on Friday and a fraction below their peak of 6.65% on Oct. 20.