* Sterling falls on BOE Inflation Report, wages data
* Yen subdued after Japan Q2 GDP contraction
* Euro drops, trades near recent lows (Recasts after BOE Inflation Report, adds comments)
By Anirban Nag
LONDON, Aug 13 (Reuters) - Sterling fell on Wednesday after a Bank of England report forecast subdued growth in wages in coming months, leading markets to push back until early next year expectations of when monetary policy will tighten.
The euro also struggled after disappointing data on euro zone industrial output, and the yen weakened against the dollar as markets digested a report that showed Japan's economy contracted in the April-June quarter.
Sterling fell to a 10-week low of $1.6716 against the dollar to $1.6825, a far cry from its July peak of $1.7192 which was its highest level since late 2008. It also fell against the euro, with the single currency rising by 0.3 percent to trade at 79.81 pence.
The Bank of England's Inflation Report, which raised growth prospects but slightly lowered inflation forecasts. And it cut forecasts for wage growth and added that a pick-up in earnings would help to determine the timing and pace of interest rate increases.
The BoE cut its forecast for wage growth this year in half, to 1.25 percent. It then expects wages to grow more strongly in 2015. Earlier, official data showed average British wages fell year-on-year in the second quarter of 2014.
The reduction in the BOE forecast led investors to push back expectations for a rate increase to February next year, from December beforehand.
"The Inflation Report was pretty dovish. Also, the UK economic data that we have seen in the past month has not surprised to the upside. So bullish bets on the pound are being unwound," said Alvin Tan, currency strategist at Societe Generale.
"But we would still prefer the pound to the euro, and if the euro rises to 81 pence, we would look to sell it."
Such views are mainly because the market still expects Britain's improving economy to prompt a rate hike in the first quarter of 2015. Poor economic data in the euro zone, by contrast, is weighing on the euro.
The euro eased 0.1 percent against the dollar to$1.3352. It was held back by euro zone data that showed factory output fell 0.3 percent on the month in June after a 1.1 percent drop in May. Forecasts were for a 0.3 percent rise.
On Tuesday, the single currency had dipped to $1.3336 after German analyst and investor morale plunged as the crisis in Ukraine took a toll. That put it within a whisker of a nine-month trough of $1.3333 set last week.
Sim Moh Siong, FX strategist for Bank of Singapore, said the euro is likely to lose more ground given the recent weakness in euro zone economic data and the potential for further monetary easing by the European Central Bank.
"I think the trajectory (for the euro) is still downwards. It's just that in the near term, there's a bit of caution in terms of positioning," Sim said, referring to a build-up in bearish bets against the euro.
Japan's economy shrank an annualised 6.8 percent in the second quarter, its biggest contraction since the March 2011 earthquake and tsunami, as a sales tax hike took a heavy toll on household spending.
The annualised contraction in gross domestic product was slightly less than forecasts for a 7.1 percent drop. But it will keep pressure on policymakers to ease policy in coming months, to ward off any risk of a prolonged slowdown caused by the tax increase.
The yen showed limited reaction to the data initially but fell in European trade. The dollar rose 0.2 percent to 102.45 yen, having traded between 103.15 yen and 101.51 yen over the past couple of weeks.
"We believe that the risk of the BoJ taking additional policy action in the coming months is underpriced. So we suggest long dollar/yen positions," Morgan Stanley said in a note. (Additional reporting by Masayuki Kitano; Editing by Susan Fenton, Larry King)