By Stefano Rebaudo

(Reuters) -Sterling rose against the U.S. dollar on Thursday but dropped to a six-week low against the euro, following weak economic data from the U.S. and the UK. 

The euro hit its highest level in almost four years against the U.S. currency as investors rushed into safe-haven assets, while remaining cautious about the impact of the U.S.-China trade deal. 

The downturn in British manufacturing was less steep than initially feared in May, but output, orders, and jobs continued to decline as companies cited recent tax hikes and U.S. President Donald Trump's tariffs. 

"Thursday's data shows the UK economy continues to face challenges," said Nick Andrews, senior forex strategist at HSBC.

"Tuesday's labour market data also loosened more than expected while Wednesday's government spending review did little to lift the outlook for growth but instead turned the focus to where potential tax rises might fall in the Autumn."

British government bond yields and the pound dropped on Tuesday after the release of weaker-than-expected labour market data that showed wage growth slowing to its lowest since September 2024, boosting bets on Bank of England rate cuts.

The pound fell 0.6% to 85.28 pence per euro after hitting 85.37, its lowest since May 2.

Analysts recently flagged that the yield spreads between the UK and the euro area pointed to sterling at 85 pence.

The Bank of England meets next week, and although it is expected to stand pat on rates, money market traders added to bets for additional rate cuts this year.

Money markets fully priced a 25 basis points BoE rate cut by September and 50 bps by year-end.

"We see a strong possibility that the Monetary Policy Committee ditches its hawkish bias, which could pave the way for an August (interest rate) cut," said Matthew Ryan, head of market strategy at Ebury.

The financial market's reaction to British Finance Minister Rachel Reeves's plans was muted on Wednesday, as many economists already expected additional taxes later this year. 

Sterling rose 0.4% versus the dollar to $1.3597.

(Reporting by Stefano Rebaudo; editing by Sharon Singleton)