UPDATE 1-Sterling hits 3-week high versus euro, recovering from sharp sell-off

* Graphic: World FX rates in 2021 tmsnrt.rs/2egbfVh

* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv (Adds news and chart, updates rates)

LONDON, Oct 5 (Reuters) – Sterling rose to a three-week high against the euro on Tuesday, recovering from a sharp sell-off last week as traders turn their attention back to the prospect of interest rate rises in Britain.

Rising inflation expectations hit risk sentiment last week and saw bond yields climb higher, pushing risk-sensitive sterling to a two-month low versus the euro and to its lowest level against the dollar since December 2020.

But by 1127 GMT, sterling was 0.3% higher against the euro at 85.14 pence, after jumping back to its highest level since mid-September.

Sterling’s recovery “seems surprising”, said Ulrich Leuchtmann, head of FX and commodity research at Commerzbank.

While the European Central Bank has no plans to raise rates soon, the prospect of imminent rate hikes, signalled by the Bank of England, is lending support to the pound again, Leuchtmann said in a note to clients.

“In view of the significant discrepancy between ECB and BoE comments, one should expect sterling to be stronger,” he said.

The pound has gained almost 5% versus the euro this year, but Leuchtmann called for cautious as it was unclear whether the BoE might “cave” in the face of the supply problems and abandon the idea of more rapid rate hikes.

The final reading of the IHS Markit/CIPS composite Purchasing Managers’ Index showed strong overall growth for companies in September, but post-Brexit shortages of staff, raw materials and transport led to slow growth in new orders.

Analysts flagged that the pound had not reacted to renewed Brexit risk after Britain told the European Union on Monday it would trigger safeguard measures in their divorce deal if the bloc failed to agree to changes to smooth trade with Northern Ireland.

European states have promised they will within days announce measures to apply pressure on London to abide by Brexit agreements.

Versus the dollar, sterling was 0.1% higher at $1.3622, not far from the week’s high, touched the previous day.

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