Sterling fell sharply against the euro on Thursday as a weak UK services sector survey and hawkish comments from the European Central Bank raised the prospect of eurozone interest rates rising before UK rates. ECB President Jean-Claude Trichet said eurozone rates could rise next month - stunning markets which were expecting a rise late this year - and pledged "strong vigilance" on rising inflation, a phrase that in the past has signalled a forthcoming rate rise.
Expectations for an early UK rate rise in contrast were scaled back after a below-forecast purchasing managers' survey on the key UK services sector. "There is a risk that the market has become too aggressive in pricing in more than two BoE rate hikes this year and against this backdrop sterling is vulnerable against the euro," said Jane Foley, currency strategist at Rabobank.
The euro rose around 1 percent on the day to a high of 85.80 pence, leaving it on course for a test of the February high of 85.93 pence. A break of this would leave the 2011 high of 86.53 pence in sight. Markets are currently pricing in a 25 basis point UK rate rise from 0.5 percent in June or July, with a further two hikes likely by the end of the year. Analysts said a rate rise before May now looked unlikely. Against the dollar, sterling was down 0.4 percent at $1.6259, having hit a session low of $1.6254, pulling away from a 13-month high of $1.6344 hit the previous day.
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