Sterling weakens as UK economy shrinks more than expected

LONDON (Reuters) -The pound weakened against the dollar and the euro on Wednesday as investors assessed an unexpectedly poor reading that signalled British economic output had contracted more than expected in July.

Sterling was down 0.4% against the dollar at $1.2449, on track for its biggest daily drop in a week, if losses hold.

The euro strengthened 0.2% against the British pound to 86.27 pence, poised for its highest level in a month.

The UK economy contracted by 0.5% in July, figures from the Office for National Statistics (ONS) showed, a worse-than-expected contraction of 0.2% and the largest drop in monthly output since December 2022.

"The decline in GDP in July suggests that underlying growth has lost momentum since earlier in the year," said Paul Dales, chief UK economist at Capital Economics.

"That would make sense given that the dampening effect of higher interest rates should be starting to be felt a bit harder now."

The Bank of England has so far raised interest rates 14 times since December 2021, taking them to a 15-year high of 5.25%.

Money market traders are pricing in around a 75% chance they raise interest rates again at next week's policy announcement and a 25% chance they remain on hold.

Other factors also weighed on growth in July, the ONS said, including strikes in hospitals and schools, while wet weather hurt output in retail and construction sectors.

(Reporting by Samuel Indyk; Editing by Amanda Cooper and Sherry Jacob-Phillips)

By Samuel Indyk