LONDON: Sterling pulled back on Monday from highs hit against the dollar late last week, as a manufacturing survey brought more worrying signs on the economy before a Bank of England meeting expected to cut interest rates to a record low.
The survey of purchasing managers for July had been forecast to replicate the results of a one-off flash poll two weeks ago. Instead, it was slightly worse, another hint of an economic backlash from June's Brexit vote.
The index fell to 48.2 in July from 52.4 in June, its lowest since February 2013. Economists from Barclays said that suggested Britain would enter a recession this year.
Sterling fell as much as half a percent in the 90 minutes after the data before recovering to trade around 0.1 percent lower on the day at $1.3207, a cent below Friday's intraday highs. It was flat at 84.60 pence per euro.
"It seems the services industry isn't the only one that had a very negative knee jerk reaction to Brexit," said Craig Erlam, an analyst with online broker Oanda. "It will be interesting now to see whether this eases up in the coming months as the dust settles."
The pound has recovered some ground since a dramatic 14 percent fall after the vote on June 23 to leave the European Union, and it gained more than 1 percent on Friday to trade above $1.33, helped by a disappointing batch of US growth data.
That has not stopped investors from steadily building "short" bets against the currency and in favour of the dollar to their highest on record.
Analysts say that suggests the pound is close to being oversold, increasing the chances of a squeeze on such positions if it does not fall further.
The prospect of the Bank of England cutting base rates below those in the United States for the first time in a decade - and possibly adding to its dormant programme of quantitative easing - may weigh on the currency before Thursday's BoE decision.
But a cut at least looks largely priced in, and a number of major banks said that adding the increasingly extreme positioning to Friday's poor US data made the dollar look vulnerable to another squeeze.
"Action by the BoE is fully anticipated by the market, with the overnight swaps rate pointing to a cut of over 30 basis points being priced," said Derek Halpenny, European head of global market research at Bank of Tokyo-Mitsubishi UFJ.
"More aggressive action than simply a cut and some changes to Funding for Lending will probably be required in order to weaken the pound against the dollar, especially given the worsening of dollar sentiment."
Since its drop after Britain's vote to leave the European Union five weeks ago, the pound has recovered about 4 percent, proving much more resilient than most major banks had forecast.
Derivatives market indications of its future value are now far more balanced.
That is despite a raft of data suggesting that confidence in the economy has fallen sharply after the Brexit vote, and that Britain may be heading for a recession.
The latest figures - showing that British consumer morale suffered its sharpest drop for more than 26 years in July - had little impact on the currency on Friday.
"We have certainly seen a normalisation of risk reversals and even implied volatility has come down significantly, which suggests the process of unwinding the pre-Brexit GBP shorts is close to complete," said Javier Corominas, head of economic research and FX strategy at Record Currency Management.
"Going forward, the market is increasingly going to ask itself what is the level of sterling consistent with a sustainable current account path for the UK. This will be highly path-dependent and driven by Brexit negotiations in large part."
Almost all analysts polled by Reuters believe the bank will cut rates by a quarter point from the current record low of 0.5 percent. A slim majority believe the BoE will hold off from announcing more quantitative easing for now, but many think that will be part of a stimulus package.
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