By Samuel Indyk
LONDON (Reuters) - The British pound was softer against the dollar on Tuesday but wasn't far from a five-month high hit late last year on expectations that the Bank of England would cut interest rates later than the Federal Reserve.
The pound was last down 0.25% against the dollar at $1.2718. It hit its highest level since August on Dec. 28 last year at $1.2825.
"The ultimate test is whether the market is right in its assumption that the Bank of England cuts interest rates five times this year," said Bank of America (NYSE:BAC) senior G10 rates strategist Kamal Sharma.
"The house view is no rate cuts this year but risks are for the easing cycle commencing in the second half of the year."
Markets currently expect the BoE to begin cutting interest rates by the May meeting, while the Fed, in contrast, is expected to begin loosening policy as early as March as inflation is stickier in the UK.
Consumer price inflation was at 3.9% in the UK in November, the highest in the G7 group of countries, although that is down from a peak of 11.1% in November 2022.
A survey last week showed Britain's economy ended 2023 on a stronger footing than previously thought, the latest sign that the BoE's tightening cycle to date might not trigger a recession.
A reading on UK gross domestic product (GDP) is due later in the week, which could provide further clues on how robust the economy is and by how much the BoE could loosen policy this year.
Charu Chanana, Saxo head of FX strategy, said the hawkish stance of the BoE, and the European Central Bank, could be challenged if economic data weakens in the first quarter.
"This could pressure the EUR and GBP, particularly if markets push forward the rate cut expectations for these central banks," Chanana said.
The pound was down 0.1% to 85.99 pence per euro after earlier hitting a three-and-a-half-week high.