FOREX-Sterling weakens after UK inflation data, dollar gains ahead of central bank decisions

(Updates headline and prices throughout, adds fresh analyst quotes)

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ECB expected to hold rates on Thursday, BoE cut fully priced

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Yen weakens as BOJ expected to raise rates on Friday

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Dollar index gains, euro edges lower

By Chibuike Oguh and Joice Alves

NEW YORK/LONDON, Dec 17 (Reuters) - Sterling fell on Wednesday after an unexpected drop in UK inflation all but guaranteed the Bank of England would cut interest rates, while the dollar rose as markets awaited central bank decisions and weighed commentary from Federal Reserve officials.

Sterling was set for the biggest one-day drop as interest rate futures priced in a near 100% chance of a quarter-point rate cut from the BoE on Thursday. Data had shown that British inflation fell much more sharply than forecast in November to 3.2%, its lowest since March, from 3.6% in October.

"The November CPI print surprised to the downside this morning. As a result, GBP is the worst performing G10 currency this morning after having outperformed yesterday," Goldman Sachs analysts led by Teresa Alves wrote in an investor note.

Sterling was down 0.53% to $1.3350, easing away from the two-month high it touched on Tuesday after data showed Britain's unemployment rate hit its highest since the start of 2021.

"For Sterling, we have noted that our view of relative underperformance is predicated on softer data, including on the inflation front, rather than a 'dovish' reaction function in itself. Today's data goes in that direction and focus will now turn to the BoE meeting tomorrow," the Goldman Sachs analysts said.

CENTRAL BANK MEETINGS IN FOCUS Federal Reserve Governor Christopher Waller said on Wednesday the U.S. central bank still has room to cut interest rates amid rising job market weakness. Waller's comments were his first remarks after the Fed cut rates as expected last week but signalled borrowing costs are unlikely to drop further in the near term, projecting just one more rate cut in 2026. The U.S. consumer price index data is due on Thursday, following softer employment data earlier this week.

"We saw the dollar weaken after the jobs data yesterday, but the move was reversed fairly quickly because I think the market seems to be kind of doubtful about the possibility of a Fed cut in January," said Vassili Serebriakov, FX strategist at UBS in New York.

The dollar index, which measures the U.S. currency against six others, rose 0.16% to 98.37, still not far from the lowest level since early October hit on Tuesday. The index is down about 9.5% this year, on track for its steepest annual decline since 2017. Markets are awaiting a host of central bank policy decisions due this week, including the BoE and European Central Bank on Thursday, as well as the Bank of Japan, which is expected to raise interest rates on Friday to a three-decade high.

The dollar strengthened 0.5% to 155.46 against the yen ahead of the BOJ meeting, where the focus will be on the forward guidance and where the policy rate is headed in 2026. Europe's largest economy continues to struggle to grow, with a survey showing that German business morale unexpectedly fell in December.

The euro was flat at $1.17415, after touching a 12-week high on Tuesday ahead of the ECB policy decision, where the central bank is expected to hold rates steady.

"I think of all these central bank meetings that are coming up, the ECB is not likely to be very impactful, but the Bank of Japan is probably the most important and where most uncertainty lies," Serebriakov said.

In cryptocurrencies, bitcoin gained 1.94% to $89,487.47. Ethereum rose 0.93% to $2,979.05.

(Reporting by Chibuike Oguh in New York and Joice Alves in London, Ankur Banerjee in Singapore; Editing by Hugh Lawson, Kirsten Donovan, Rod Nickel)