Sterling at four month low against euro as UK and euro zone rates diverge

LONDON (Reuters) -The pound dropped to its weakest level against the euro in four months on Friday as a weekly decline in gilt yields on soft British data contrasted with higher European yields on expectations the European Central Bank is done with rate cuts.

The euro reached as high as 87.27 pence, up 0.24% and approaching its April 11 peak of 87.38 pence, hit at the height of tariff-induced market turmoil. A break past that would take the euro to its highest since late 2023.

The pound was also down 0.4% against the dollar at $1.3456.

Data on Friday showed British retail sales for June were slightly below analysts' expectations, albeit rebounding from a sharp drop in May.

They followed figures on Thursday showing UK business activity grew only weakly in July and employers cut jobs at the fastest pace in five months.

The jobs data is the most important aspect of this, said Derek Halpenny, head of research global markets EMEA at MUFG, as rate setters at the Bank of England are most focused on the labour market.

As a result, yields on British government bonds, or gilts, are set for small weekly falls across the curve, in contrast with European government bond yields, which are up sharply on signs of a U.S.-EU trade deal and hints from the ECB that it is done with interest rate cuts. [GVD/EUR] [GB/]

This "notable divergence" is sending euro/sterling higher, said Halpenny.

The BoE has hitherto been much more cautious about rate cuts than the ECB and most other European developed market central banks due to stubbornly high British inflation.

The ECB has cut by 200 basis points since last year, in contrast to just 100 bps from the BoE.

However, while ECB could now be done with easing, markets continue to anticipate two further 25 bps BoE cuts this year, and see around an 80% chance of the first of those at its early August meeting.

Analysts say should UK inflation slow, the pace of cuts could accelerate. Though with inflation hitting its highest in a year in June, they say the BoE has a difficult balancing act.

(Reporting by Alun JohnEditing by Mark Potter)