Sterling rallied to a three-week high against the dollar and was on track for its biggest one-day gain versus the euro in a month on Tuesday, as investor angst about a Greek default and Greece's possible exit from the euro zone pushed them into safer havens. Those inflows helped the pound recover from losses sustained after data showed British consumer prices inched up just 0.1 percent in May, disappointing expectations of a stronger pick-up in inflation and the knock-on effect on interest rate hopes.
Sterling rose to $1.5647 in afternoon trade in London, its highest since May 22, recovering from a low of $1.5542 hit after the inflation data was released. The euro fell 0.7 percent to 71.77 pence, its lowest for two weeks. The single currency was broadly lower as Italian, Spanish and Portuguese bond yields leapt in one of the most serious episodes of contagion since the height of Europe's debt crisis after the latest breakdown in talks between Greece and its creditors. Credit Agricole currency strategist Adam Myers said the pound was benefiting from safe-haven flows.
"Even without this contagion catalyst there are still plenty of good reasons to expect sterling capital inflows in coming months - after all, residual flows held back in the first-quarter due to the UK elections likely still exist," he said. The pound has broadly risen as some of the uncertainty from May's national election lifted with recent data showing Britain's economy growing more than previously estimated last year and in early 2015.
Still, with inflation and wage growth rather subdued, traders do not expect the Bank of England to raise rates in a hurry. Tuesday's data showed inflation turned positive again after dipping below zero in April for the first time in 55 years, suggesting Britain's flirtation with deflation was brief. "We may not be completely out of the woods. We think it's probable that over the next couple of months (inflation) will still be printing around zero and we may even dip back into the negative," Morgan Stanley's head of European FX strategy, Ian Stannard, said.
Minutes from the BoE's latest Monetary Policy Committee (MPC) meeting will be released on Wednesday. Most expect the minutes to show all nine MPC members voted to keep interest rates at record lows, though one economist in a Reuters poll expected one member to have voted in favour of a hike. "At the moment I don't think there's anything there to push the hawks to vote for a hike just yet," Stannard said. "I think (sterling) is going to come under a little pressure because there's nothing there to provide any fresh impetus."
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