* Graphic: sterling and gilt yields bit.ly/2dgAXn1
* Graphic: World FX rates in 2017 tmsnrt.rs/2egbfVh
* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv
By Jemima Kelly and Saikat Chatterjee
LONDON, Sept 27 (Reuters) - Sterling rose to a 10-week high against the euro on Wednesday, lifted by data showing British retail sales growth hit a two-year high during the first part of this month, which bolstered bets on a Bank of England rate hike in November.
The pound edged up from a two-week low against the dollar which was stronger across the board after the U.S. Federal Reserve Chair Janet Yellen said the previous day that the central bank should continue gradual rate hikes and that it would be “imprudent” to wait until consumer price growth had reached the bank’s target of 2 percent.
The dollar hit its highest in five weeks against a basket of currencies. The pound fell as much as 0.7 percent to $1.3364 in early London trade, its weakest since Aug. 14.
But sterling edged up after the UK data to trade at $1.3424 by 1035 GMT, still down a quarter of a percent on the day. Against the euro, it strengthened to 87.50 pence, its strongest since July 17.
The Confederation of British Industry (CBI) said its retail sales balance jumped to +42 in September from a reading of -10 in August, the highest since September 2015 and far above all forecasts in a Reuters poll of economists.
Sterling had rallied almost 6 percent against the dollar earlier this month to a 15-month high above $1.3650, on rising expectations the Bank of England will raise interest rates in November. But it has come under pressure this week as predictions of a U.S. hike have prompted investors to cut short dollar bets.
Uncertainty over the direction of Brexit negotiations - which recommenced this week in Brussels - also continues to weigh on the pound, which has fallen more than 10 percent against the dollar since before Britain’s June 2016 referendum on European Union membership.
“Most of the sterling recovery over the last two weeks is probably related to a repricing of expectations on BOE policy, which means that the pound still trades with a significant Brexit risk premium,” said SEB currency strategist Richard Falkenhall.
“Any sign of progress in Brexit negotiations would probably reduce the risk premium and strengthen the pound. We have revised our forecasts in euro/sterling lower.”
Many market watchers remain sceptical about the British economy’s ability to stomach an interest rate increase, and traders say hawkish rhetoric from policymakers will have to be matched by underlying improvement in data to radically change expectations.
“In view of unquantifiable Brexit risks coupled with a slowing economy and burgeoning household debt, it is our contention that... limits (to sterling strength) cannot lie too far above current spot rates,” wrote BNY Mellon currency strategists in a note to clients. (Reporting by Jemima Kelly and Saikat Chatterjee; Editing by John Stonestreet and Raissa Kasolowsky)