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(Reuters) -Sterling fell to a fresh 21-month low versus the dollar on Wednesday as Britain's weak economic outlook and higher than expected government borrowing dented the Bank of England's (BoE) monetary tightening narrative.
Money markets have been scaling back bets on the size of BoE rate hikes, pricing in around 140 basis points (bps) worth of tightening by year-end from 160 bps last Friday. [IRPR]
Data showed that government borrowing in the 2021/22 financial year was almost 20% higher than forecast.
British retail sales slumped in April, with the first fall in volumes in more than a year, adding to signs of a slowdown in the economy.
Unicredit forex strategist Roberto Mialich said he expected a further scaling back of expectations for BoE monetary tightening in the medium term as he forecast the BoE to raise its policy rate to 1.25% in the third quarter with no further increases in 2022.
"Of course, any headline about a slowdown in growth or increasing public debt weakens expectations for future monetary tightening, weighing on the pound," he added.
Sterling fell 0.4% to its lowest since July 2020 at $1.2523.
The pound "could remain vulnerable as the dollar retains some momentum," ING analysts said.
However, "the 1.2500 support could prove a rather strong one," they added.
Sterling rose 0.6% to 84.10 pence versus a weakening single currency.
The euro lost almost 1% against the greenback on growth concerns after Russia cut off gas supplies to parts of the euro zone.
The BoE, which convenes its Monetary Policy Committee next Thursday, looks set to take its first steps towards selling some of the 875 billion pounds of government bonds it amassed between 2009 and 2021, in a move that will trigger additional monetary tightening.
But ING analysts recently argued the bank might hold off selling gilts due to the weak economic backdrop.
The BoE said it would be "considering beginning" outright bond sales when its main interest reached 1%, which is supposed to happen next week, according to market expectations.
(Reporting by Stefano Rebaudo Editing by Mark Potter)