Sterling drops to 12-week low as business activity contracts

By Samuel Indyk

LONDON (Reuters) - A deteriorating global growth picture sent the pound to a 12-week low against the dollar on Tuesday after a survey showed business activity in Britain contracted last month.

The UK S&P Global/CIPS composite Purchasing Managers' Index (PMI) dropped to 48.6 in August from 50.8 in July, the lowest since January, although it was revised up from an earlier estimate of 47.9. The services sector PMI printed at 49.5, below the half century mark that separates growth from contraction.

"The forward-looking indicators in today's services survey remained downbeat as companies reported a slight decline in new business," said Martin Beck, chief economic advisor to the EY Item Club.

"The more dovish signals from today's survey are consistent with the ... view that we are now close to the end of the current monetary tightening cycle."

The Bank of England, which has raised its key interest rate 14 consecutive times to 5.25%, is expected to go ahead with a 25 basis point rate hike later this month.

Markets are pricing in another hike after that to 5.75% by early next year even as other major central banks, such as the U.S. Federal Reserve and European Central Bank, appear close to the end of their respective tightening cycles.

"Even though rate pricing has come back from the peak, there's still the risk that the Bank of England delivers less hiking than the market is priced for," said Adam Cole, chief currency strategist at RBC Capital Markets.

"When there's a pivot to start pricing in the first rate cuts, that will be a very negative sterling event," Cole added, noting that he is still negative on Britain's currency.

The pound was last down 0.5% against a stronger dollar at $1.2565, having earlier dropped to $1.2529, its lowest level since June 13.

Cole noted that much of today's move in the pound is dollar driven, "with sterling in the middle of the pack".

The dollar index, which measures the U.S. currency against six peers including the pound, was up 0.4% at 104.61, getting a lift after weak activity data from Europe and China.

Meanwhile, the euro gained 0.1% against the pound to 85.55 pence.

(Reporting by Samuel Indyk; Editing by Shinjini Ganguli)