Sterling weakens on fresh evidence of slowing inflation


Oct 8 (Reuters) - Sterling fell against the dollar on Wednesday, after two days of gains, on signs of easing British inflation which could allow the central bank to keep interest rates low.

The Bank of England's Monetary Policy Committee starts a two-day meeting on Wednesday and is expected to keep rates at record lows. The BoE has opted to keep policy ultra-loose, despite a sustained economic recovery, as wages are still subdued.

On Wednesday, there was more evidence of declining price pressures. Prices in British shops fell last month at a faster pace, driven down by a steep decline in prices for non-food products, the British Retail Consortium said. Retail prices in September were 1.8 percent lower than a year earlier, the BRC said.

The data came just hours before a survey from mortgage lender Halifax showed UK house price growth is likely to moderate going into next year. In the three months to September, house prices rose 9.6 percent on an annual basis, the pace easing slightly from 9.7 percent growth during the three months to August.

The pound was down 0.1 percent against the dollar at $1.6080 , potentially heading for its first loss in three days. The dollar drifted higher as traders added positions ahead of the release of minutes from the Federal Reserve's most recent policy meeting.

"A lot of the good news has already been priced into the pound," said Peter Kinsella, currency strategist at Commerzbank. "And we expect the dollar to continue climbing from more."

The minutes from the U.S. central bank's rate-setting Federal Open Market Committee (FOMC) are due at 1800 GMT and investors will be looking for indications of how soon the Fed plans to raise interest rates.

Sterling was flat against the euro which, at 78.775 pence , held its ground despite diverging growth prospects and contrasting outlooks for monetary policy between the euro zone and Britain.

While investors are pricing in a chance of a rate hike by the BoE in the spring of 2015, expectations are growing that flagging growth in the euro zone and the threat of deflation will drive the European Central Bank to opt for quantitative easing.

The IMF said on Tuesday that Britain would be the fastest-growing major economy in 2014. Its forecast of 3.2 percent growth for Britain contrasted with cuts in forecasts for the euro zone's three biggest economies - Germany, France and Italy. Italy's economy would shrink by 0.2 percent this year, it said.

The IMF also said it sees a 30 percent chance of the euro zone slipping into deflation over the next year, and nearly a 40 percent probability the currency bloc could enter recession. The UK would leave its crisis behind, it said.

The pound had surged more than 15 percent against the dollar in the year to mid-July on expectations the BoE would raise interest rates before its peers in the United States and Europe.

But it has fallen almost 7 percent in the three months since as expectations of a rate hike by the end of 2014 faded. Uncertainty in the lead-up to the Scottish independence referendum that was held in mid-September also drove speculators to place bets against the pound.

Some analysts say the drop in the pound could have run its course and were recommending investors to buy it on dips.

"Sterling/dollar sell-off is overdone," said Petr Krpata, currency analyst at ING.

"The risk of a decline in U.S. inflation leading to a reversal of market expectations of the future U.S. rate profile and our view that the BoE is still on track to start the tightening cycle in February 2015 all point to a rebound to $1.66 levels."