LONDON (Reuters) - Sterling fell on Tuesday from its recent peak above $1.70 (1 pound) after data showed British inflation dropped more than expected in May, tempering expectations the Bank of England will raise interest rates later this year.
Sterling dropped to a day's low of $1.6938 GBP=D4 after a report showed UK inflation fell to a 4 1/2-year low, from around $1.6977 beforehand. It was also hurt by a stronger-than-expected increase in U.S. inflation, which pushed the dollar up in the afternoon session. Sterling was last trading at $1.6955, down 0.2 percent on the day. ECONUS
The pound rose past $1.70 for the first time in nearly five years on Monday as expectations grew that the BoE will tighten policy before the end of the year.
The euro gave up some of its earlier gains to trade flat at 79.90 pence, having risen to 80.09 pence EURGBP=D4 after the UK inflation data. The euro had hit a 20-month low of 79.59 on Monday as the gap between euro zone bond yields EU10YT=RR and British gilts GB10YT=RR widened the most since 1997, reflecting the diverging monetary policies of the European Central Bank and the BoE.
Governor Mark Carney surprised investors last Thursday by saying rates might rise before many were predicting, prompting investors to bring forward expectations for a first UK rate hike to before the end of this year from the first quarter of 2015. GBPOIS=ICAP
His deputy Charlie Bean added fuel to market speculation that the balance of opinion on the bank's policy committee may be shifting in favour of raising rates. A known dove, David Miles, has also said he expects to vote for a hike in interest rates before next May, The Times of London reported on Tuesday.
"The inflation data will go some way to abating the aggressive calls for a rate hike from the BoE this year, especially so following Carney's hawkish comments last week and other more recent comments from MPC members since," said Alex Edwards, head of corporate desk at UKForex.
"We could well see one or two votes for a rate hike at the last meeting when the MPC minutes are released tomorrow. The BOE governor may have been prepping the market for such a scenario, but this recent inflation data will put a small dent in expectations for a rate hike this year."
Analysts said the tone of recent comments from policymakers had bolstered expectations that the minutes due on Wednesday would be hawkish.
"The pound remains below the $1.70 level and the minutes to the June meeting could well be the determining factor as to whether we see a break of the $1.7043 level reached in 2011," said Simon Smith, head of research at FxPro.
Sterling gained more than 10 percent in the past year on expectations a rapidly improving UK economy would prompt the BoE to raise rates before its peers in Europe and the United States. But the rally had stalled in the past month after Carney warned markets in mid-May not to expect swift action.
Also limiting a rise by the pound were expectations for macro-prudential measures to cooling the British housing market.
The BoE's Financial Policy Committee meets on Tuesday and the Financial Stability Report is due on June 26. Analysts say that a more targeted approach by the BoE's FPC to tamping down the housing market is likely to allow a more broad-based recovery to gain momentum and underpin the pound.
Reporting by Anirban Nag; Editing by Larry King