LONDON (Reuters) - Sterling lost ground against both the dollar and euro on Tuesday after a weaker-than-expected reading of business sentiment among manufacturers added to arguments for another prolonged hold in Bank of England interest rates.
The pound has suffered along with the dollar from a week of turmoil around China's financial markets and economic outlook which has trimmed some bets on the prospect of rises in UK and U.S. borrowing costs.
Central bank policymakers seem for the moment unfazed though, with Bank of England (BoE) chief Mark Carney reiterating over the weekend that the bank will have some serious thinking to do on rates come the turn of the year, bolstering sterling in early trade.
A European Central Bank (ECB) meeting this week is also expected to sound some kind of dovish note to push back against several cents of gains for the euro over the past week.
"Our house view is that currencies will continue to be driven by policy divergence," Bank of America Merrill Lynch strategist, Kamal Sharma, said.
"Now that has been derailed somewhat by the events in China but we have an ECB meeting this week that should give a more dovish outlook and that should focus the market's attention back on that underlying story."
Sterling interest rate forwards for the first quarter of next year have come in around 10 points from highs hit in July when bets on a September hike by the U.S. Federal Reserve - and the BoE following early next year - were growing.
That retreat on rate expectations has helped pull the pound back from near 8-year highs around 69 pence per euro.
On Tuesday it was trading half a percent lower at 73.47 pence per euro, having fallen as far as 73.74 pence after the manufacturing survey. It was marginally lower against the dollar at $1.5340.
But there were a number of other voices among the major banks forecasting a stronger performance this week. A rise in mortgage approvals in July to their highest since February 2014 also added to signs the housing market is regaining momentum and that the BoE should hold its nerve and raise rates next year.
"The pound was particularly hard hit last week and we think this week is an opportunity to position for a recovery," RBC Capital Markets strategist, Sue Trinh, said.
Editing by Louise Ireland