LONDON Dec 19 Sterling fell against the dollar on Thursday, after the U.S. Federal Reserve's decision to cut bond-buying gave a boost to the greenback.
Investors also took profit on the pound's recent rally after UK retail sales data came mostly in line with expectations, wrong-footing some who had positioned for a strong number. Those expectations gathered steam after a dive in jobless numbers on Wednesday drove the pound higher.
The dollar extended gains made after the Fed said on Wednesday it would reduce its monthly asset purchases by $10 billion, bringing them down to $75 billion. A reduction in Fed stimulus lifted U.S. bond yields and buoyed the currency.
Sterling was last trading 0.2 percent lower on the day at $1.6350, compared with $1.6386 before the UK retail sales data was released.
The euro also gained around 0.1 percent against sterling, rising to 83.515. It posted its biggest daily loss against the pound in 10 months on Wednesday.
"We think that against the dollar, sterling does appear a bit overbought. In the near term we could see sterling give back some of its gains as the Bank of England will also try and reinforce a dovish message," said Sasha Nugent at Caxton FX.
She added that the way the UK economy was holding up and the jobless rate was falling, the focus would turn to expectations of the BoE hiking rates in early 2015, while the Fed was still in the midst of withdrawing stimulus and well away from tightening.
"That should offer sterling a lot of support," she added
The pound has risen against the dollar this year, with gains picking up in the last six months as the UK economy has improved faster than many of its European peers and investors have priced in the chance of an earlier than expected rate hike by the Bank of England.
The BoE said in its forward guidance in August that it would not consider raising rates until unemployment fell below 7 percent, something it expected to happen by the end of 2016. It was forced to revise that message, stressing rates would not rise any time soon, after admitting unemployment could hit 7 percent as early as the fourth quarter of 2014.
After Wednesday's data which showed the jobless rate at 7.4 percent, sterling overnight interbank average rates moved higher to price in the chance of a rate hike within 15 months, compared with two years before the data was released.
"Just as the Fed has altered its forward guidance this week, there is speculation that the BoE may have to follow suit," said Jane Foley, senior currency strategist at Rabobank.
"We currently anticipate the first BoE rate hike in May 2015. Give the buoyancy of most UK data releases, the market will start to bring forward its expectations for a hike unless the Bank acts to contain speculation. For now we expect sterling/dollar to remain well supported."