Sterling eases after UK economy unexpectedly contracts in January

By Yadarisa Shabong

(Reuters) -Sterling lost some ground versus the dollar on Friday after data painted a grim picture of the British economy, and it softened against the euro as prospects of a German debt deal lifted the shared European currency.

The British pound fell as much as 0.25% to $1.2918 before clawing its way back up to $1.2943. But it was still not far off its four-month peak of $1.2990 hit on Wednesday. 

British gross domestic product contracted unexpectedly by 0.1% in January compared with December. A Reuters poll of economists had forecast a monthly expansion of 0.1%.

Analysts said they do not expect the weak reading to lead to the Bank of England turning dovish on interest rates.

The British public's expectations for inflation in the long run rose in February to their highest level in more than five years, a Bank of England survey showed on Friday, likely underscoring its cautious approach to cutting rates.

"For GBP we do think the weaker growth data is an important reminder that UK cyclical and fiscal dynamics may continue to be more challenging than elsewhere," said Dominic Bunning, global forex strategist at Nomura.

The euro rallied on Friday as German Chancellor-in-waiting Friedrich Merz reached an agreement with the Greens on a massive increase in state borrowing in Europe's largest economy, sources close to the negotiations said.

That sent the euro up 0.5% on the pound to 84.225 pence.

Analysts have seen the pound as a relative safe haven as U.S. Donald Trump escalates a global trade war, due to the more balanced trading position between Britain and the U.S.

Unlike the European Union, Britain has refrained from announcing tit-for-tat tariffs against the U.S. after Trump's steel and aluminium tariffs came into force on Wednesday.

After enjoying its biggest weekly gains against the dollar in more than two years last week, sterling is set to eke out another 0.1% rise this week.

(Reporting by Yadarisa Shabong in Bengaluru, editing by Alun John and Hugh Lawson)