LONDON (Reuters) - Sterling edged lower against the dollar and euro on Monday, holding off 10-day highs hit last week, as traders awaited key wages data due later this week for clues to the pace of monetary tightening from the Bank of England.
Markets have moved to price in an interest rate hike in May, but such tightening will hinge on pay growth picking up, and on whether Prime Minister Theresa May can soon secure a transition deal for the two years after Britain quits the European Union.
The shift in market expectations followed a hawkish BoE meeting that said interest rates would need to rise sooner and by more than it had previously expected, in order to get inflation back on target within two years rather than three.
But analysts say a flat labour market report on Wednesday could dampen those expectations. It would also be a source of concern for the BoE, which has predicted an acceleration of wage growth in 2018.
“The Bank of England has hung its hat on the assumption that there will be wage inflation ... and that Brexit will be smooth. The signal they gave us that they are positioning for a May interest rate hike relies on this assumption,” Rabobank currency strategist Jane Foley said.
Investors have also become nervous about Brexit negotiations, after starting the year confident that Britain would secure a transitional deal. Sterling slumped earlier this month when the EU’s chief negotiator Michel Barnier said such a deal was “not a given”.
Sterling was down 0.2 percent at $1.3998 GBP=D3 by 1707 GMT, just over 2 percent down from an 18-month high hit in late January. Against the euro it was down a similar amount to 88.59 pence per euro.
Positioning data released on Friday showed speculators trimmed their bets on further sterling strength against the dollar for a third straight week, though they were still net-long the currency. [IMM/FX]
“We must stress that (Brexit) negotiations are only just starting and one might bear in mind that trade negotiations are quite hard to settle,” wrote Didier Borowski, head of macroeconomic research at Amundi, in a note to clients.
“Our base case scenario foresees an intermediate relationship (between Britain and the EU), with free trade in goods but only very partial passporting in financial services,” they added. “There is clearly scope for the pound to depreciate in this scenario.”
Editing by Richard Balmforth, Larry King