LONDON: Sterling rose on Wednesday, bolstered by better-than-expected UK services sector activity in May which kept alive expectations of monetary tightening by the Bank of England early next year.
By late afternoon trade, the pound climbed to $1.6755 , having traded at around $1.6705 beforehand, and slightly higher on the day. It had fallen to a low of $1.6699 earlier in the European session.
The euro lost ground, hitting a low of 81.235 pence from around 81.48 pence beforehand.
British government bond prices fell for a fourth consecutive day, taking 10-year yields to a three-week high as markets digested strong British services PMI data and focussed on likely policy loosening from the ECB on Thursday.
The Markit/CIPS services purchasing managers' index (PMI) ticked down to 58.6 in May from 58.7 in April - still outpacing a Reuters poll forecast of 58.2 in May and well above the 50 mark that denotes growth.
"The PMI reading was better than expected and that has helped sterling," said Manuel Oliveri, FX strategist at Credit Agricole.
"But with the dollar recovering broadly, we think the pound's gains in the short term against the dollar will be capped. Against the euro, diverging monetary policy outlooks will drive the pair."
Longer U.S. Treasury yields have risen 20 basis points in the past week and added around another five in U.S. trade, prodding the dollar higher broadly.
But the UK services sector data brought the focus back to Britain's economic recovery. The UK economy posted its fastest annual growth in more than six years in the first quarter and is expected to grow about 3 percent in 2014, outpacing other big industrialised nations.
As a result, investors expect the Bank of England to begin raising rates early next year, in stark contrast to the European Central Bank which will still be in easing mode, and probably at least a few months ahead of the Federal Reserve.
Sterling had run up to a 5-1/2 year peak against the dollar earlier in May. Over the last year the pound has appreciated some 10 percent against a basket of currencies on the growing assumption that the improving economy and red-hot housing market will force the BoE to raise rates faster than its major peers.
"Robust data has allowed the pound to weather position adjustment in May with relatively little damage, and with long positioning now cut back we see scope for renewed outperformance," BNP Paribas said in a note.
"We remain short euro/sterling accordingly."
The ECB is widely expected to ease policy on Thursday, a move which should weigh on the euro. ECB sources told Reuters last month the bank was preparing a package of policy options, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms.
As well as the ECB, Thursday brings the Bank of England's monthly policy meeting, but economists expect no change in rates as the central bank waits for the economy to gather more strength before tightening policy.
Ten-year gilt yields peaked at 2.695 percent, a level last seen on May 13, and at 1405 GMT were 3 basis points higher on the day at 2.68 percent, with prices on track for their sharpest four days of losses in three months.
Gilt yields were little changed versus 10-year Bunds , with the spread widening fractionally on the day to 124.6 basis points.
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