By Fanny Potkin and Jemima Kelly
LONDON, Oct 10 (Reuters) - Sterling strengthened against a weaker dollar on Tuesday, as forecast-beating British industry data cemented expectations that the Bank of England will raise interest rates for the first time in over a decade at its next policy meeting in November.
British factories had their strongest two months of 2017 in July and August, data showed earlier on Tuesday, suggesting the BoE remains on track to raise interest rates soon, though the deficit in trade in goods hit an all-time high.
The Office for National Statistics (ONS) said manufacturing output rose by a monthly 0.4 percent in August, faster than a forecast for output to rise 0.2 percent in a Reuters poll of economists.
Sterling climbed on the data and built on those gains later in the day, dragged up by a euro that was lifted by strong data from Germany, which weighed on the dollar.
By 1555 it was up 0.6 percent on the day at $1.3216, leaving it around 1.5 percent higher than its lows at the end of last week, when it recorded its worst performance in a year.
“(Sterling’s) rebound comes after a sharp drop at the end of last week ... Thus, at this stage, one has to take this latest rebound with a pinch of salt, as it could be a counter-trend move which could ultimately fail to sustain itself,” said Forex.com analyst Fawad Razaqzada.
The pound was broadly unchanged against the euro at 89.34 pence.
Sterling strengthened on Monday after the Office for National Statistics (ONS) said British labour costs were growing more strongly than previously announced.
“The short-sterling market has moved to price in an even greater probability of a BoE hike on the back of the ONS report,” Credit Agricole said in a note.
“Money markets are already pricing in more than 75 percent chance of a hike at the November inflation report.”
Concerns about turmoil within the governing Conservative party have subsided after British Prime Minister Theresa May vowed to ward off challenges to her leadership and signalled the possibility of a cabinet reshuffle.
But some strategists believe that markets are not taking into account political risks and are focusing too much on possible rate hikes.
“The material deterioration in the political background has been largely ignored as monetary policy has dominated,” said Adam Cole, the head of FX Strategy at RBC. He recommended selling into the sterling rally, given the high possibility of a “GBP-negative events”.
Trevor Greetham, an analyst at Royal London Asset Management, agreed.
“The Bank of England may find itself in the same credibility trap if interest rates rise while Brexit outcomes are unclear and economic data is soft,” he said. (Editing by Robin Pomeroy)