Sterling steady near $1.31 with inflation data in focus

The British pound hovered around $1.31 against the dollar on Monday ahead of a pivotal inflation report, while speculators raised their bullish positions on the currency to the highest since 2014, data showed on Friday.

The pound has surged in June and July - last week hitting its highest since April 2022 at $1.3144 - as markets ratchet up expectations for interest rate rises as British inflation, the highest in the G7, makes slow progress in falling back towards target. Sterling was last little changed against the dollar at $1.3094.

The Office for National Statistics releases its latest inflation data on Wednesday. Although analysts expect headline consumer prices to moderate, core inflation, which strips out volatile energy and food components, is expected to remain at an elevated 7.1%. Stubbornly high inflation prompted the Bank of England to raise its key interest rate by 50 basis points in June. Another 50 basis point rate hike has not been ruled out next month.

Money market traders price around a 70% chance of a 50 basis point hike in August and around a 30% chance the BoE downshifts to a 25 basis point hike. In contrast, the Federal Reserve appears close to the end of its tightening cycle as inflation falls back towards 2%, while a slowing euro area economy has traders questioning how much further the European Central Bank has to go.

"Sterling can react positively to interest rate rise speculation as long as the UK economy continues to be resilient," said Rabobank's head of FX strategy, Jane Foley. "But, if data suggest the risks of a hard landing are growing, sterling may be prevented from reacting positively to rate hike expectations."

Meanwhile, data from the Commodity Futures Trading Commission released on Friday showed speculators raised their net long position in the pound by 699 million dollars to 4.693 billion dollars in the week to last Tuesday, the largest such position since mid-2014. When investors hold a long position in an asset, they typically expect its value to increase.

"The market has enlarged those long sterling positions on the perception that the BoE has a long way to go relative to other central banks," Rabobank's Foley said. "Because the market is so long, you run into the risk that there will be some profit taking on those positions if the economic data begins to disappoint."

The euro was last up 0.1% against the pound to 85.88 pence, its highest level in nine trading days.