Pound rocked by tough-talking Fed ahead of BoE decision

By Harry Robertson

LONDON (Reuters) - Sterling inched higher on Thursday as it recovered some of its steep losses suffered late on Wednesday when the U.S. Federal Reserve officials sent the dollar surging by scrubbing out two rate cuts from next year's projections.

The focus in UK markets on Thursday is on the Bank of England, which is expected to hold interest rates at 4.75% as persistent inflation limits its room for manoeuvre despite a slowing economy.

The pound was last up 0.3% at $1.2611, after dropping 1.08% in the previous session as the dollar rallied.

Against a basket of six peers, the dollar jumped 1.18% on Wednesday.

The Fed lowered interest rates by 25 basis points (bps) but policymakers estimated they would be likely to lower borrowing costs by just 50 bps next year, 50 bps less than they envisaged in September.

The changes pushed up yields on U.S. government bonds, making them relatively more attractive and boosting the dollar.

"The market was blindsided by the surprising hawkishness," said Steve Englander, head of global FX research at Standard Chartered.

"The market impact was particularly sharp because most of the market expected a really low volatility (Fed meeting)."

Britain's pound has been one of the strongest performers against the surging dollar this year but has fallen around 1% since January.

Data this week showed growth in UK wages sped up in the three months to October and inflation rose to an eight-month high of 2.6% in November.

The figures cemented traders' bets that the BoE will hold rates on Thursday and caused them to lower their expectations for rate cuts next year. They now only see two further 25 bp rate cuts as likely in 2025, after two reductions in August and November this year.

Sterling has rallied sharply against the euro this year in a sign of the diverging paths of the BoE and European Central Bank, which is expected to deliver four or five rate cuts next year as the bloc's economy sputters.

The euro held broadly steady against the pound at 82.44 pence on Thursday, not far from the 2-1/2-year low of 82.26 pence touched last week.

(Reporting by Harry Robertson; Editing by Peter Graff)