Sterling edges lower after UK inflation eases as expected

(Updates throughout)

By Ozan Ergenay and Joice Alves

LONDON, Nov 19 (Reuters) - Sterling edged lower after data on Wednesday showed British consumer price inflation fell to 3.6% in October, the first drop since May, with traders increasing bets the Bank of England will cut interest rates in December.

Consumer price inflation fell to 3.6% in October from September's joint 18-month high of 3.8%, as expected by the BoE and economists polled by Reuters.

The data cemented expectations that the BoE could cut interest rates in December, while elsewhere investors struggled for direction and U.S. agencies cleared a backlog of data after a prolonged government shutdown.

"Today's report could give the BoE more ammunition to cut interest rates next month, although we still think that the decision will be on a knife edge, and we do not expect interest rate future prices to change too dramatically on the back of this report," Kathleen Brooks, research director at XTB, said.

Markets now see an 86% chance of a 25-basis point BoE rate cut in December, up from an 80% chance priced on Tuesday, according to LSEG data.

Brooks said that there was another labour market report and inflation print due before the December BoE meeting, which may shift the dial for rates and could limit the immediate downside for gilts and for the pound.

The BoE paused its quarterly pace of rate cuts earlier this month and finance minister Rachel Reeves has said she would seek to avoid tax and spending measures that might add to inflation in her annual budget on November 26. "The budget is the next main driver for the pound. If Rachel Reeves' fiscal plans do not convince the market that she has a credible plan for fiscal consolidation over the rest of this parliament, then we could see bond yields spike again and this could weigh heavily on the pound," Brooks added.

Sterling was down 0.17% against the dollar at 1.3133, its lowest since Friday, when British markets were whipped around as speculation swirled around the highly-anticipated budget.

The euro was up 0.07% against sterling at 88.14 pence, having traded as high as 88.64 pence on Friday, its highest since April 2023.

(Reporting by Ozan Ergenay and Joice Alves; Editing by Andrew Heavens and Alex Richardson)