* Sterling eases from 3-month high vs dollar GBP=D4
* Euro falls 1 percent vs sterling on less hawkish ECB
* UK service sector data enhances case for rate hike By Neal Armstrong
LONDON, Feb 3 (Reuters) - Sterling pared gains versus the dollar on Thursday in a move driven largely by a sharp drop in the euro after European Central Bank President Jean-Claude Trichet dampened expectations for a rate hike in the euro zone.
Trichet’s comments, which came after the ECB’s decision to keep interest rates at a record low 1 percent as expected, disappointed investors who had expected a more hawkish statement after recent inflation data came in above forecast.
The pound had risen to a three-month high versus the dollar in morning trade after UK services PMI data came in above expectations, bolstering the case for higher interest rates in the UK. [ID:nSLA2DE7OU]
The euro traded down around one percent EURGBP=D4 at a two-week low of 84.39 pence, falling below its 200-day moving average around 84.56.
“Cable has been dragged lower by a fall in euro/dollar this afternoon, but we expect it to remain well bid. Our year-end target is $1.70,” said Chris Turner, head of currency strategy at ING Capital Markets.
Sterling GBP=D4 traded down around 0.3 percent at $1.6140 in afternoon dealing after rising as high as $1.6279 on the UK PMI data.
“We see further modest upside potential toward the mid $1.60s - based on the BoE following through with a rate hike, possibly as early as May,” said Lee Hardman, currency strategist at BTM-UFJ.
Activity in Britain’s dominant services sector expanded at its fastest pace in eight months in January as business recovered after December’s snow disruption. [ID:nSLA2DE7OU]
Thursday’s purchasing managers’ survey from Markit/CIPS also showed a record jump in input cost inflation in the services sector, which is likely to worry Bank of England policymakers who hold their rate-setting meeting next week.
“We would hesitate at this stage to say that the recovery is back on track. With so much uncertainty about the underlying pace of growth, we still doubt that the MPC will want to risk tightening policy prematurely.” said Vicky Redwood, Senior UK Economist at Capital Economics.
Implied interest rate futures based on overnight index swaps were almost fully priced for a 25 basis point rate rise in May, up from around 40 percent last week after a shock 0.5 percent contraction in UK fourth quarter gross domestic product. BOEWATCH
Markets are also pricing in an 18 percent chance that the BoE will hike rates as early as next week.
Attention in the UK now switches to next week’s BoE rate announcement, while the Bank’s quarterly inflation report will also be under close scrutiny later in the month.
“Inflation has clearly going higher but the BoE has banked on weak activity in the economy to justify its position on interest rates. That position has been weakened somewhat by the latest data,” said Turner at ING.
Editing by Toby Chopra