Sterling down for second day ahead of key data week

LONDON Thu Dec 12, 2013 12:11pm EST

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LONDON Dec 12 (Reuters) - Sterling reversed early gains to trade lower against a stronger dollar on Thursday as investors positioned their portfolios for critical data next week.

The pound was down 0.3 percent against the dollar at $1.6329 in its second day of losses. It had earlier risen as high as $1.6418, not far from the two-year high of $1.6468 it had hit earlier this week.

The euro was 0.1 percent up against the pound at 84.23 pence, not far from Wednesday's three-week high.

The dollar rose against the pound as an upbeat U.S retail sales report suggested recovery in the world's largest economy is on a stable footing.

The pound was also hit by profit-taking after a long rally - driven by growing optimism about the strength of the UK economy and bets the UK could be the first major central bank to raise rates - that has lifted it from below $1.50 in July.

"Perhaps sterling had overshot the improvement in near-term fundamentals, so the correction was overdue," said Lee Hardman, currency economist at BTMU.

"I still think the fundamentals are moving in favour of a stronger pound."

Trading volumes against both the dollar and the euro were below average levels recorded over the past month, according to data from the Reuters dealing platform, meaning price moves may be exaggerated.

The British Chambers of Commerce said on Thursday that Britain's economy will expand at its fastest rate in seven years in 2014, thanks to strengthening household consumption.

But the pound's strength could be tested next week by inflation and unemployment data and minutes from the Bank of England's December meeting.

"At the moment the market likes to trade a good UK figure," said Lee McDarby, executive director, corporate FX sales at Nomura International.

"If the UK recovery seems to remain on course when next week's economic figures are released then the pound should do well, especially with markets getting thinner and more illiquid as we reach year end."

Gilt prices ended the session lower, tracking a sharp drop in Treasuries.

The yield on 10-year gilts rose 4 basis points to 2.90 percent, broadly in line with Bunds. The yield on five-year gilts rose by 2.5 bps, outperforming after a well-received five-year gilt auction.

At its sale of 2019 gilts, Britain attracted bids worth more than twice the 4.5 billion pounds on offer, a much better result than at the previous auction of this gilt three weeks ago.

Gilts have been trapped in a tight range over the past month, with upside limited by the strength of recent data and the downside limited by the Bank of England's assurance that it will be in no rush to raise rates.

"Britain's recovery is clearly surprising on the upside but it's being driven by the sectors that are the most sensitive to low interest rates," said Lena Komileva, managing director at G+ Economics.

"How sustainable the recovery will be should interest rates rise is questionable."

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