LONDON, Oct 27 (Reuters) - Sterling slipped to a three-week low against a stronger dollar on Friday, as uncertainty over prospects for the British economy dampened bets that a likely Bank of England rate hike next week would signal the start of a sustained tightening cycle.
Though a rise in borrowing costs after the next BoE policy meeting on Nov. 2 is largely priced in by the market, the prospect of a dovish hike, one which will not be followed by further rate rises, has put downward pressure on the pound.
While the United States is in the midst of rolling back years of record-low interest rates, the likely BoE rate hike will be Britain's first in over a decade.
Though rates are expected to double, the move would only reverse measures taken by the Bank to mitigate against the possible impact of Brexit last year.
"Raising interest rates should always probably be followed by a stronger currency. But that may not be the case next week," said Edward Hardy, economist at foreign exchange services company WorldFirst.
If the BoE does not vote unanimously on the hike, he added, this will indicate to investors that a sustained cycle of tightened monetary policy would be unlikely to follow.
"It would add to the theory that next week's hike - if and when it does take place - will be more of a move just to retrace action we saw in the wake of the Brexit vote last year," Hardy said.
Sterling hit its lowest levels against the dollar since Oct. 9 on Friday at $1.3070 but recovered some ground to trade at $1.3114 but was still down 0.3 percent on the day.
The pound fared better against the euro, hitting highs not seen since the start of the month, as the common currency dipped on a European Central Bank announcement on Thursday that it would begin weaning the euro zone off loose monetary policy.
Further clues about the health of the British economy and outlook for BoE interest rate policy could be provided by two U.K. credit rating reviews, due to be released on Friday by ratings agencies Fitch and Standard & Poor's.
Data from British mortgage lender Halifax on Friday showed public confidence in the outlook for house prices has dropped to its lowest in nearly five years, weighed by pessimism about the economy.
Uncertainty over the progress of Brexit negotiations and domestic political divisions also continued to weigh on the pound.
"News emerging about the Scottish First Minister challenging Theresa May to formally say whether the government is pursuing a transition deal adds to the Brexit headache," said Alvin Tan, currency strategist at Societe Generale. (Reporting by Polina Ivanova; Editing by Saikat Chatterjee and Richard Balmforth)