LONDON, March 21(Reuters) - Sterling fell on Tuesday as broader market fears about banks subsided and the focus shifted to the outlook for interest rates, with the Federal Reserve and Bank of England (BoE) both due to meet this week.
After a tumultuous few weeks in financial markets, shares in European banks rallied on Tuesday for a second consecutive day, with fears of contagion assuaged following UBS Group's state-backed takeover of Credit Suisse on Sunday.
By 1205 GMT, the pound was 0.2% down against the dollar at $1.22560 , and 0.7% lower against the euro at 87.940 pence .
Relative calm extended to forex markets where traders turned their attention back to interest rate expectations, which have shifted dramatically in recent days.
The Fed will announce its next rate decision on Wednesday, while the BoE will convene on Thursday, as will the Swiss National Bank and Norwegian central bank.
As of Tuesday morning, markets were pricing in a 44% chance of no change from the BoE, and a 56% chance of a 25 basis-point increase .
UK inflation data on Wednesday will also be closely watched and is expected to show some easing.
"The data has been somewhat more mixed of late, with growth holding up better than expected and the labour market continuing to run hot," said Stuart Cole, head macro economist at Equiti Capital, though he also pointed out that wage growth is showing signs of slowing, and services inflation may have peaked.
"And of course there is the similar need to address the fragile financial market conditions. Overall I think we get a hike from the BoE, and this should continue to provide support for sterling."
Vasileios Gkionakis, European head of FX strategy at Citi, expects the BoE to leave the base rate unchanged given recent deceleration in inflation and wage growth, writing in a note on Tuesday that recent market tensions "should also contribute to this decision".
"We think it is a very close call between rates having peaked and the BoE delivering one more rate hike later; however, our bias is that the central bank is done tightening," Gkionakis said.
Reporting by Lucy Raitano; Editing by Amanda Cooper and Jan Harvey
Source: Reuters