Pound at highest against euro since September

LONDON (Reuters) – The pound touched its highest against the euro in four months on Tuesday, supported by indications that the British economy is holding up and the Bank of England will likely cut rates later than its peers.

The euro dropped as low as 85.48 pence, its lowest since early September and was last down 0.12% at 85.53 pence.

Versus the dollar, the pound was little changed at $1.2711.

Sentiment towards the UK economy is “generally improving”, said analysts at Monex Europe.

“Sterling longs are best played on a relative value basis against cyclically weak currencies (i.e. euro and Canadian dollar), with both already paying out over a percent year-to-date,” they added.

Data on Tuesday showed Britain recorded a smaller-than-expected budget deficit for December, potentially opening up room for tax cuts in a budget scheduled for March.

The main medium-term question for the British currency is whether the Bank of England will lag the Federal Reserve and the European Central Bank when it comes to rate cuts, and by how much.

Thursday’s ECB meeting could offer some clues. No change in rates is expected and attention will focus on how strongly officials push back on market expectations of an ECB rate cut as soon a April.

Market pricing shows roughly a 50% chance the BoE will begin cutting rates in May, though this may also be too soon for the bank which has voiced concern about sticky inflation.

“A lot will need to go right for an easing cycle to begin as early as May, especially in the midst of a still hawkish Bank of England focussing more on late-cycle variables, such as wage growth and services inflation,” said analysts at Deutsche Bank.

The yen was volatile after a meeting at which the Bank of Japan maintained its ultra easy policy settings, but markets picked up signals that an end to its negative interest rate policy was approaching.

The pound was last steady at 188.11 yen, just below last week’s high of 188.91 yen, which was its highest since 2015.

(Editing by Christina Fincher)