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By Samuel Indyk
LONDON (Reuters) -Sterling was flat against the dollar and rose against the euro on Wednesday, having briefly lost ground against both currencies following publication of a report detailing COVID lockdown-breaching parties at the office of Britain's prime minister.
A failure of leadership was to blame for a culture that led to the alchohol-fuelled gatherings being held, the report by senior official Sue Gray said.
After its conclusions emerged, sterling fell as much as 0.4% against the dollar but by 1432 GMT was flat at $1.2530. Against a weakening euro, the pound extended gains to 85.21 pence, or 0.5%.
The report was expected to heap further political pressure on Boris Johnson to resign, though betting markets showed his prospects of staying put had improved following the report. He said that, while he took responsibility for the parties, he would not quit.
Chances of Johnson being replaced this year had fallen to 28% from 35%, according to London-based betting site Smarkets.
"As traders speculated over just how untenable Boris Johnson’s position as Prime Minister is, sterling fell further against the dollar and the euro before making up some ground," Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown, said in an email.
Analysts were also focused on a slowing economy and decades-high inflation.
Data on Tuesday showed a sharp slowdown in British business activity in May, with S&P Global's flash Composite Purchasing Managers' Index slumping to a 15-month low, adding to fears that the economy will slip into recession.
"It's really a bearish cyclical, structural and fundamental story for the pound which is keeping it weak," said Vanda Research senior strategist Viraj Patel.
"There probably is more pain to come, less against the dollar but certainly certain crosses, like euro/sterling."
Traders slightly scaled back expectations for Bank of England interest rate hikes following Tuesday's data, with money markets now pricing in around 118 basis points of tightening by year-end.
BoE Chief Economist Huw Pill said, in an interview published on Wednesday, he thought more tightening was needed but not necessarily to a "super restrictive" stance.
The Bank of England has raised rates four times since December, with markets fully pricing in another 25 basis point rate hike in June.
"We still think probably the BoE is close to being done with the hiking cycle, give or take one or two more hikes, getting the bank rate to 1.5%" Patel said.
(Reporting by Samuel Indyk; editing by Dhara Ranasinghe, Gareth Jones and John Stonestreet)