Sterling drops as Carney cools hike expectations, euro benefits

Matt Cardy I Getty Images

Sterling extended losses on Wednesday, falling sharply against the euro as investors cut favorable bets on the currency after Bank of England governor cooled expectations of an interest rate hike later this year.

The euro was the main beneficiary of the pound's losses, and stayed firm against the dollar. The single currency also made gains against growth-linked and less-liquid currencies like the and New Zealand dollars amid geopolitical concerns in the Middle East which have knocked down shares.

Continue to short the euro: FXCM

Surprisingly less hawkish comments from BoE Governor Mark Carney on Tuesday drove currency markets, sending the pound to a one-week low of $1.6953 and pulling further away from a 5-1/2 year peak of $1.7064 set last Wednesday. The euro was up 0.2 percent at 80.30, rising past stop-loss buy orders at 80.25 pence.

Carney said Britain's economy still has plenty of slack to work through and that financial markets underestimated how much uncertainty there was in the economy.

Read MoreIsthe BoE making up policy as it goes along?

Analysts said the impression he left was a slightly dovish one and contrasted with his hawkish speech earlier this month. The resulting uncertainty was driving speculators to trim huge bets placed in sterling's favour.

"The net result in the very near term may be that from a very overbought position technically, the pound will see a correction, towards $1.6920 against the dollar and 81.10 for euro/sterling," said Kit Juckes, currency analyst atSociete Generale.

Dollar awaits GDP revision

Here's the downside to the US dollar rally

The drifted lower against the yen with some investors cautious ahead of the final reading of first-quarter U.S. GDP data. It is forecast to be revised down and could boost expectations that the Federal Reserve is in no hurry to tighten policy.

Influential Federal Reserve policymaker, William Dudley, said on Tuesday the U.S. central bank could reasonably wait until mid-2015 to raise interest rates without risking an undesirable rise in inflation.

The was down 0.1 percent versus the yen at 101.85 while the was up at $1.3615. The dollar index was slightly lower at 80.295, despite a rise in U.S. two-year Treasury yields which often supports the dollar.

Read MoreAre carry trades getting risky?

"Power is building up and dollar/yen is likely to move significantly in either direction if a break does occur," said Bart Wakabayashi, head of forex at State Street in Tokyo.

"Talk is that stop orders are building up steadily at 101.50 yen and 102.50 yen. Market players are currently trading within this narrow band to make a little change. Overall, the yen looks better bid unless the Bank of Japan comes up with its next easing plan."

Japanese CPI will be released on Friday and any fresh signs of the country escaping deflation are likely to further curb prospects for additional BOJ easing.