Sterling set for its biggest weekly rise since Dec 2020 vs dollar

May 20 (Reuters) - Sterling was set for its biggest weekly gain since December 2020 against a weakening dollar as the latest economic data suggested the market might not need to scale back its expectations for Bank of England rate hikes much further.

The U.S. dollar was headed for its worst week since early February, showing fatigue after the currency's breathless 10%, 14-week surge.

Money markets are fully pricing in another 25-basis-point interest rate rise at the BoE's June meeting and 128 basis points of tightening by the end of the year, up from around 115 bps on Tuesday right after solid labour market data.

British retail sales jumped unexpectedly in April, official data showed on Friday.

On Friday, the pound was down flat against the dollar at $1.246, after rising 1.65% this week - the biggest weekly gain since the 2.3% in the week ending Dec 18, 2020.

"UK retail sales have come in a little better than expected and break/suspend the narrative that the cost of living squeeze is large enough to derail the Bank of England tightening cycle," ING analysts said.

This week's data showed Britain's jobless rate hitting a 48-year low in the first three months of 2022. Consumer price inflation rose 9% in April, while a Reuters poll of economists had pointed to a reading of 9.1%.

According to Unicredit analysts, long-term models suggest the British currency is undervalued against the dollar and the euro, but "less aggressive BoE, focusing more on UK GDP growth concerns, might weigh on sterling".

They expect the BoE to hike rates much less than the forward rate, creating a "repricing risk for the GBP, as long as investors further scale back rate-hike expectations".

However, the central bank's chief economist, Huw Pill, said on Friday the BoE would need to raise interest rates further to combat the risk of self-perpetuating price rises.

Sterling rose 0.1% versus the euro to 84.74 pence.

"New-found hawkishness at the ECB means that EUR/GBP may struggle to sustain a move below 0.8450 before returning to 0.8600," ING analysts said.

The pound has been showing a high correlation with risky assets, while their outlook remains challenging in the face of central banks' tightening and risks of an economic slowdown.

(Reporting by Stefano Rebaudo; Editing by Alison Williams)