Feb 15 (Reuters) - Sterling slumped against major peers on Wednesday, breaking a seven-day rally against the euro, after a bigger-than-expected drop in UK inflation in January raised expectations the Bank of England may end its interest rate hiking cycle soon.
Data showed British consumer price inflation fell to 10.1% last month, more than the 10.3% expected and down from December's 10.5%.
Declines in underlying measures of price growth that are being closely watched by the central bank also dropped, lending weight to signals from the BoE that inflation could have peaked.
The pound fell 0.8% to $1.2083 against a broadly stronger dollar, retreating from near two-week lows and on course for its sharpest one-day decline this month. It had fallen as much as 0.9% to $1.20715 during the session.
The euro-sterling pair jumped 0.6% to 88.7 pence after losing more the 1% over the last seven sessions.
"While the risk of a sharp recession may have lessened, the easing in price pressures may persuade the Bank of England to take a slightly less hawkish approach at upcoming MPC meetings," Matthew Ryan, head of market strategy at payments and FX company Ebury, said.
"Swap markets now see just two more 25bp rate hikes from the BoE, with a 50/50 chance of a first rate cut by year end. This is less aggressive than expected from both the U.S. Federal Reserve and the European Central Bank, which could present some near-term downside for the pound against its major peers," he said.
The BoE delivered its 10th straight interest rate hike earlier this month, raising rates by 50 basis points to 4.0%, and signalled that peak rates may be in sight - a relief for the economy that recorded zero growth in the last quarter of 2022.
BoE rate-setters have since provided mixed signals, with some, including Jonathan Haskel and Catherine Mann urging tighter policy.
"A key risk against lower UK inflation is the tightness of the labour market and the power of unions to force through higher wage increases amid strikes," Daniel Casali, Chief Investment Strategist at wealth manager Evelyn Partners, said.
On Tuesday, U.S. consumer price data briefly knocked the U.S. currency against most peers, before it found footing as investors assessed that interest rates will stay elevated for longer as inflation remained sticky.
(Reporting by Susan Mathew; editing by Barbara Lewis)