By Lucy Raitano
LONDON (Reuters) - Sterling was struggling on Thursday to recover from a sharp tumble the day before, its biggest daily drop in seven weeks, as markets turned nervous about the impact of rate hikes on the British economy.
The pound was broadly steady against the dollar at $1.2638 by 0928 GMT, and also flat against the euro, which was worth 86.35 pence.
"It's a relatively quiet day from a data perspective, so overall I would not be surprised to see sterling somewhat licking its wounds today ahead of its next battle," said Stuart Cole, chief macro economist at Equiti Capital.
The pound on Wednesday dropped 0.88% against the dollar, its biggest daily fall since mid May and also lost ground on the euro.
Cole said that tumble was a result of suggestions from Bank of England Governor Andrew Bailey that interest rates could continue to rise, hurting the British economy, and difficulties at Britain's largest water supplier, Thames Water, "stoking fears about wider difficulties in the corporate sector as firms struggle to cope with the rapid increase in borrowing costs."
"The final nail in the coffin was (Federal Reserve chair) Powell, who basically confirmed another U.S. interest rate rise in July and possibly at least one more after that."
Previously, expectations that the United States was at the end of its rate hiking cycle while the European Central Bank and Bank of England had more to do, had sent the dollar lower against the pound and euro in the first half of this year.
However, investors are now starting to worry that further rate hikes in Britain in a bid to curtail entrenched inflation are bad news for the economy and also the pound.
Inflation remains stubbornly well above the Bank's 2% target, and fears that price rises are becoming entrenched in the UK economy are leading traders to increase their bets on further rate increases from the central bank.
They see a 65% chance of a 50-basis-point rate rise at the BoE's next meeting on Aug. 3, and a 25% chance of a 25 bps rise, with bets that the BoE's Bank Rate - currently at 5% - could go as high as 6% by the end of 2023.
The BoE has already raised the rate 13 times since late 2021 from 0.1% to try to calm inflation.