* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh
* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv
By Jemima Kelly
LONDON, Feb 1 (Reuters) - Sterling strengthened on Thursday, recovering from losses earlier in the week, as concerns over Prime Minister Theresa May’s leadership eased and expectations grew that the Bank of England to take a more hawkish tone in its meeting next week.
Reports that May was facing a leadership challenge from members of her own party, as well as criticism from the House of Lords, which said in a report that her Brexit legislation plans contained “fundamental flaws”, weighed on the currency earlier in the week.
But the pound has been recovering since Tuesday, when Bank of England Governor Mark Carney struck an upbeat tone on the economy and said focus was turning to inflation, which investors thought might mean interest rate would rise faster. The central bank meets next Thursday.
“There were a couple of things in there that suggested things were more optimistic,” said ING currency strategist Viraj Patel, in London. “He (talked about) focus shifting back to curbing inflation, which suggested that maybe they’re looking at a hike in 2018.”
Patel said sterling had also been able to recover because of the absence of bad news this week.
“Domestic political noise will act as a limiter for sterling, but it won’t actively weigh on it. Once that noise doesn’t escalate, or there’s no new catalyst, the natural tendency is for the pound to just revert some of those losses,” he said.
A report that showed British manufacturing lost more momentum than expected last month, with activity falling to a seven-month low, took some shine off sterling but was not enough to knock it into negative territory.
By 1000 GMT the pound was trading up 0.4 percent up at $1.4244, having earlier reached $1.4275. Against the euro, it was up 0.1 percent at 87.36 pence.
The pound reached its highest levels on a trade-weighted basis since late June 2016 in the aftermath of the Brexit vote last week. It was just a half a percent off that high on Thursday.
Since the EU referendum, sterling is still down around 9 percent on a trade-weighted basis, but it is up about 8 percent from a trough reached in October 2016.
“With the currency having returned to more ‘normal’ levels recently, we foresee a slower pace of gains for the rest of 2018, mainly against the dollar, before the pound trade-weighted index trend appreciation re-accelerates in 2019,” Credit Agricole strategists wrote in a note to clients. (Reporting by Jemima Kelly, editing by Larry King)