LONDON: Sterling traded firm near a one-month high against the euro on Thursday, helped by expectations that a sustained UK recovery would prompt the Bank of England to tighten policy earlier than flagged. In contrast, expectations are gathering pace that the European Central Bank may flag more monetary stimulus in coming months to support an economic recovery and stave off deflationary pressures that are showing signs of emerging. The euro was flat at 84.05 pence, not far from a one-month low of 83.79 pence hit on Thursday. Against the dollar, too sterling was steady at $1.6080, having gained more than 1 percent this week on the back of some robust services and industrial sector data. The better-than-expected British data could see the Bank of England bring forward its forecast for when unemployment will hit the 7 percent level at which it would consider raising rates. Currently it sees this happening in 2016. The Bank of England delivers its rate verdict at 1200 GMT, but is not expected to make changes. Focus will be on next week's Inflation Report where the bank could revise up its growth outlook and change its expectations of the jobs market. "The two-year swaps are increasingly pricing in rate hikes whilst one-year euro/sterling risk reversals are close to multi-year lows. What this means is that investors should use rallies to establish short euro/sterling positions," said Peter Kinsella, currency strategist at Commerzbank. Sterling overnight interbank average rates - the very short-term interest rates which form the basis of lending costs to the wider economy - are pricing in a 30 percent chance of a rate move in two years and a slim risk of a move in 18 months. Yield spreads between 10-year British gilt yields and German Bunds have expanded, rising to levels last seen in late September. The favourable yield differentials have given an excuse to investors to sell the euro in favour of the British pound. The ECB will announce its rate decision at 1245 GMT and while most expect no change in its refinancing rate, currently at a record low of 0.5 percent, there are a few who are looking for a rate cut. Even if the ECB does not lower the refi rate, expectations are strong that it will flag looser policy in coming months -perhaps as early as next month. "The market has not fully priced in an ECB rate cut yet, so while a cut is unlikely today, euro/dollar will drop a couple of big figures were a rate cut to become priced into the December meeting, as our economists expect," Societe Generale said in a note. "We reiterate our preference for expressing bearish euro trades via short euro/sterling."

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