London - Sterling rose towards one-year highs against the euro on Friday, with the latter coming under broad pressure after softer-than-expected euro zone inflation bolstered the case of more easing by the European Central Bank.

In contrast, market expectations as reflected in the short sterling strip were pricing in a rate hike by the Bank of England in the fourth quarter of 2014.

The gap between two-year gilt yields and euro zone government bonds widened to its highest in 3-1/2 years, underpinning the pound against the euro.

The euro fell 0.35 percent to 81.92 pence with some banks like RBS calling for a 15 basis point rate cut by the ECB next week. Growing expectations of a rate cut by the ECB could see the euro test its recent one-year low of 81.68 pence struck last week.

Earlier, data showed euro zone inflation slowed to 0.7 percent year-on-year in January, well below a reading of 0.9 percent and much lower than ECB's target of 2 percent.

“There is speculation that the ECB may cut rates next week which is putting euro under pressure,” said Alvin Tan, currency strategist at Societe Generale. “Euro/sterling is headed lower towards January lows where we think there will be some support.”

Tan said sterling was unlikely to rise much against the dollar given markets had become too aggressive about pricing in a rate hike this year by the Bank of England.

Governor Mark Carney repeated on Wednesday a rate rise was not on the horizon any time soon.

That and concerns over the still fragile structure of an upturn based on rising house prices have given sterling bulls some food for thought.

Sterling was down 0.1 percent against the dollar at $1.6465 with bids from Middle East buyers cited at $1.6450.

The dollar also rose after the Commerce Department said that consumer spending increased 0.4 percent after rising by a revised 0.6 percent in November.

While sterling may struggle to make much headway against the dollar, many analysts expect the pound to gradually gain against the euro this year.

“It is still one of our top picks for this year - we expect it to outperform strongly against the euro - but it probably needs the dust to settle on this emerging weakness before we can get back to that trend,” said Phyllis Papadavid, senior global FX strategist at BNP Paribas in London. - Reuters