March 20, 2018 / 9:10 AM / in a month

Sterling drops as inflation slows more than expected

LONDON (Reuters) - Sterling fell against the dollar on Tuesday after UK inflation slowed more than forecast in February, the first of several sets of data in a week when the Bank of England is expected to signal interest rates will rise as early as May.

UK pound coin plunges into water in this illustration picture, October 26, 2017. Picture taken October 26, 2017. REUTERS/Dado Ruvic

A Brexit transition deal agreed between Britain and the European Union, which sent sterling soaring on Monday, appeared to clear the way for a hike, with markets factoring in a 70 percent chance of one despite the subdued inflation number, which also undercut analyst forecasts.

Against the dollar, sterling had traded up 0.2 percent at $1.4054 before the data was released and then fell below $1.40. It traded down 0.1 percent at $1.4015 at 1545 GMT.

It built on gains versus the euro, which sold off broadly as the dollar rebounded. The pound rose 0.4 percent to 87.635 pence per euro.

Viraj Patel, an analyst at ING, said UK core inflation of 2.5 percent was “high and sticky enough” to warrant the Bank of England’s inflation-driven tightening bias.

“Lower inflation means UK real wage squeeze is reversing and that is positive for consumption growth,” he said.

Wage growth and employment numbers are due on Wednesday, the day before the BoE decision. The central bank has signalled that it wants to see wage pressures building before it hikes rates.

“It’s still likely that the Bank of England will signal on Thursday that an interest rate hike is coming in May. Given yesterday’s positive news around the Brexit transition deal, the odds for a rate rise have shortened significantly,” said Jake Trask, FX Research Director at OFX.

The pound hit a one-month high of $1.4088 on Monday after the deal on a 21-month transition following Britain’s departure from the EU next year. The two sides are now clear to negotiate what their future trading relationship will look like.

Sterling has been one of the best performing major currencies in the last year, boosted by growing confidence that a disorderly Brexit will be averted.

Reporting by Tommy Wilkes; Editing by Peter Graff and John Stonestreet

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