Sterling fell versus a firmer euro on Monday and was seen vulnerable before UK data this week, including inflation and jobs numbers, which could add to the view that interest rates will stay on hold in the coming months. Data on Tuesday is expected to show inflation ticked up to 4.2 percent in April from 4.0 percent in March, but most in the market believe recent signs of a shaky UK economy will prevent the Bank of England from raising rates from historic lows soon.
Jobs data on Wednesday and retail sales numbers on Thursday could add to this view, while the release of BoE meeting minutes on Wednesday will be watched closely for any shift in tone from policymakers. "Sterling is very much a sell on rallies at the moment," said Audrey Childe-Freeman, currency strategist at J.P. Morgan Private Bank. "The market looks to be focusing on the environment of deteriorating growth and higher inflation, which is not a good backdrop for interest rate hikes".
The euro was up 0.6 percent at 87.60 pence, helped by steady buying by Asian central banks and off a seven-week low of 86.73 pence hit last week. The euro was broadly firmer as concerns ahead of a meeting of euro zone finance ministers eased after German Chancellor Angela Merkel said debt restructuring would be "damaging" to eurozone credibility.
Traders said the euro could fall back if concerns over Europe's debt crisis resurface and dent the shared currency. Euro zone finance ministers are likely to back a bailout for Portugal on Monday and are also expected to pressurise Greece to deliver on agreed fiscal and privatisation targets if it wants new emergency financial aid next year.
"We expect sterling to do better against the euro as a number of hedge funds are still long on the euro and we could see some of those positions being unwound," said Michael Derks, chief strategist at FXPro. Against the dollar, sterling was up 0.2 percent at $1.6237, helped higher by gains in the euro against the US currency which kept the pound above a low of $1.6147 hit on Friday, its weakest in more than five weeks.
A drop below Friday's low could see the pound target its 100-day moving average, currently around $1.6121, and then $1.6046, the 50 percent retracement of the rally from late December to early May. Sterling lost considerable ground against the dollar last week after a steep selloff in commodity prices prompted investors to rush towards the relative safety of the dollar and the yen.
The pound had risen above $1.65 on May 11 after the BoE raised its inflation forecasts in its quarterly report. An above-consensus inflation number on Tuesday could lift it again if it fuels speculation that the central bank may hike interest rates earlier than expected. Currently, investors are not fully pricing in a quarter percentage point rate hike in the UK until January next year. In contrast, markets are pricing in the chance of at least two further quarter percentage point rate hikes by then by the European Central Bank.
"This week's BoE minutes as well as CPI data will be important to gauge whether the BoE is maintaining a wait and see approach," BNP Paribas said in a note. "While we are more pessimistic than the BoE regarding the likely longevity of the current UK slowdown, so long as the deleveraging in oil continues, the sovereign euro bid could reverse near term."