By Amanda Cooper
LONDON (Reuters) - The pound edged higher on Friday but hovered near two-week lows after a string of central bank decisions this week reinforced expectations that the Bank of England will not deliver another jumbo rate hike next week.
Sterling was last up 0.1% against the dollar at 41.2813 and up 0.2% against the euro at 85.58 pence.
Against the yen, sterling fell earlier by as much as 1.1% to its lowest in over a month, after the Bank of Japan said it would make its yield curve control policy more flexible, which investors initially took as a sign the central bank might be edging towards a shift in its ultra-loose monetary policy.
The sharp rally in the yen reversed, leaving sterling up 0.2% on the day at 178.77 yen.
The BoE meets on Aug 3 and, right now, traders are leaning more towards a rate increase of 25 basis points, but still see a 25% chance of another half-point rise.
"The pound is struggling to book gains amid diminishing expectations that the Bank of England will be able to continue hiking rates aggressively," City Index strategist Fiona Cincotta said.
Investors are still betting heavily on a stronger pound and hold their most valuable bullish bet on sterling since 2014.
But interest-rate differentials, which have been one of the major upward drivers for sterling this year, have eroded this month, as the likelihood of a rise in the UK to beyond 6% from 5% right now, has diminished in line with data that has shown inflation is cooling and parts of the economy are slowing.
As a result, the premium of two-year gilt yields, which respond the most to changes in rate expectations, over two-year Treasury yields has collapsed to almost zero this month, from a multi-year high of around 45 basis points.
The Fed this week left open the possibility of more rate increases and excluded easing financial conditions anytime soon, which in theory supports the dollar.
European Central Bank President Christine Lagarde on Thursday signalled that she did not believe there was much more ground to cover in terms of rate hikes and that any decisions on policy would depend on incoming data.
The pound is now heading for a weekly gain of 1.1% against the euro, its largest this year.