September 12, 2017 / 7:40 AM / in a year

Sterling holds strong before inflation data

* Graphic: sterling and gilt yields

* Graphic: World FX rates in 2017

* Graphic: Trade-weighted sterling since Brexit vote

By Patrick Graham

LONDON, Sept 12 (Reuters) - Britain’s pound headed back towards five-week highs around $1.32 on Tuesday ahead of inflation data that should support the case for a more hawkish message on the outlook for interest rates from the Bank of England this week.

Consumer price inflation unexpectedly held steady in July, bucking market expectations for a renewed rise, after fuel prices fell and the effect of the pound’s tumble after last year’s Brexit vote started to fade.

Economists expect it to have risen to 2.8 percent in August, way above the BoE’s 2 percent target, strengthening the case for a rise in official borrowing rates next year.

Two members of the Bank’s Monetary Policy Committee are already voting for higher rates, in part in defence of the pound.

Any more defections to that camp on Thursday would be liable to drive the currency higher although, with the economy struggling this year, most traders remain sceptical of the Bank’s ability to raise rates at all.

“Inflation has been steadily rising in the UK and the latest forecast suggests this trend is continuing,” analysts from retail broker FxPro said in a morning note.

“Such increases do leave the door open for the Bank of England to hike interest rates, but that is unlikely with the current sluggish growth in the UK.”

The passing of the government’s umbrella EU repeal bill in a vote overnight eased some of the political noise around the Brexit process that has dominated the past month.

But signs that London is struggling to make progress in the initial stages of talks with Brussels have provoked a buildup of bets against the currency since the start of August.

Those sales have come as a number of major banks predicted the pound could for the first time weaken to less than parity with the euro, although sterling has proved more robust in the past week.

Having strengthened to less than 91 pence per euro for the first time in almost a month on Monday, it rose 0.1 percent to 90.67 pence on Tuesday and also gained 0.3 percent to $1.3203.

“We are now starting to see the risk premium-related overshoot in EUR/GBP unwind,” ING analysts Viraj Patel and James Knightley wrote in a note on the inflation release.

“A hawkish hold at this week’s BoE meeting could fuel a further correction towards - and potentially below - the 0.90 level, which would almost certainly shelve any EUR/GBP ‘parity’ fears for now.” (Editing by Kevin Liffey)

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