LONDON Sterling fell by around a third of a percent on Thursday after British retail sales dropped more than expected in September, another sign that one of the developed world's brighter economic recoveries is slowing.
The impact was eased by subdued expectations for the data and by the prospect of a more upbeat first estimate of third-quarter economic growth on Friday.
But the 0.3 percent decline on the month, largely ascribed to better weather that kept winter clothes sales down, was enough to knock sterling back against both the dollar and the euro.
"Sterling has been very sensitive to data over the past couple of weeks and that is clearly because of the repricing in expectations for Bank of England interest rates," said Michael Sneyd, a strategist with BNP Paribas in London.
"It seems like against the dollar we may see a dip back below $1.60 in the next few days, or even the next few minutes."
Sneyd said he remained broadly positive on the pound now that most of the long-term "long" trades have been cleared out. Those trade drove an year-long rally in sterling until the middle of this year.
Even with political nerves around elections next year and the prospect of a referendum on whether to leave the European Union thereafter, the British economy has still looked in better form than its European peers.
"We still like the pound in this economic divergence story," he said. "When rate hikes do arrive, the Bank of England is still likely to be ahead of the rest in raising. Once we see some better economic data, I think investors will be able to put any political concerns aside."
After the initial moves, sterling trod water for much of the day, resisting a sustained move back below $1.60. By 1425 GMT, it was 0.25 percent lower at $1.6010 and 0.2 percent down at 79.125 pence per euro.
British government bond prices also fell modestly, following German Bunds and U.S. Treasuries lower after some positive economic data from the euro zone and United States.
At 1350 GMT, the 10-year British gilt yield was up around half a basis point on the day at 2.22 percent, not far off a session high of 2.231 percent hit after data pointed to a strengthening of U.S. labour market conditions.
Two of the Bank of England's nine policymakers voted at their meeting this month to raise interest rates, but minutes of the meeting released on Wednesday showed most of them saw "few signs" of inflationary pressure building. That suggested their debate over tighter monetary policy was losing some steam.
Money market pricing for a rate hike has now been pushed out to the third quarter of next year.
Friday's gross domestic product report is expected to show growth of 0.7 percent on the quarter, putting the economy on track for an expansion of around 3 percent for the year, more than triple the growth of the euro zone.
"Sterling's problem really is that interest in it as a trade has fallen off a cliff in the past month," said a spot trader with another bank in London.
"If growth were to perk up, that might well help, but it will probably take a bit more than one piece of data to get people back in the trade."
(Editing by Alison Williams)