By Lawrence White and Gertrude Chavez-Dreyfuss
LONDON/NEW YORK (Reuters) -Sterling hit one week-highs against the dollar and euro on Thursday, recouping earlier losses, amid broad weakness in the greenback, as investors bet on a more aggressive tightening by the Bank of England (BoE) over the next few meetings, in line with recent moves from other major central banks.
The recovery in the pound was also due in part to technical factors, analysts said.
Sterling posted its largest daily percentage gain versus the dollar since October 2020. Against the euro, the pound had its best day since early May.
The BoE on Thursday raised interest rates by a quarter of a percentage point, confounding forecasts by some market participants who were looking for a bigger hike to fight soaring inflation.
"The pretty swift rebound in the pound is a reflection of the market's growing confidence that a more aggressive pace of policy normalization is likely to be on the way in H2," said Matthew Ryan, senior market analyst, at global financial services firm Ebury.
He added that swap markets were now pricing in more than 100 basis points of hikes from the BoE's Monetary Policy Committee (MPC) in the next two meetings through September, up from around 73 bps before Thursday's meeting.
"We continue to expect the MPC to raise interest rates at every meeting during the remainder of the year, although it will likely need to join the '50 club' in order to satisfy investors. Expectations for central bank policy tightening globally are so high that standard 25 basis point moves are becoming increasingly insufficient in order to trigger currency appreciation," Ryan said.
The pound was last up 1.6% against the dollar at $1.2367, after earlier hitting a one-week high of $1.2405. The euro also fell to one-week lows versus sterling, and last traded down 0.4% at 85.52 pence.
Kenneth Broux, a strategist, at Societe Generale in London, said market positioning was "very short sterling and stops probably got triggered after sterling rose above $1.21 and it carried on from there."
Expectations the BoE would hike by more than 25 basis points had grown after the U.S. Federal Reserve on Wednesday delivered its biggest hike since 1994 and the Swiss National Bank then shocked markets on Thursday with a large surprise hike of its own.
The BoE instead opted for a smaller increase, although it was the central bank's fifth consecutive hike as it strives to fight rising prices without hurting Britain's embattled economy.
Analysts and investors said the tentative hike should support the pound, albeit longer term pressures remain on the currency versus the buoyant dollar.
The benchmark FTSE index index fell 2.58%, while 10-year UK government bond yields rose to 2.6%. GB10YT=RR
Britain's growth prospects are seen among the weakest for developed countries in 2023, and there is uncertainty over how fast the BoE can tighten policy this year to tame inflation without further dampening economic activity.
Sterling has weakened around 8.5% against a robust dollar since the start of the year given the grim outlook for the economy and political instability in Britain.
(Reporting by Lawrence White in London and Gertrude Chavez-Dreyfuss in New York; Additional reporting by Joice Alves and Sujata Rao-Coverley in London; Editing by Carmel Crimmins, Mark Potter, Mark Heinrich and Alex Richardson)