* Sterling eyes BOE economic update, wages data
* Yen subdued after Japan Q2 GDP contraction
* Euro drops, trades near recent lows (Updates prices, adds comments)
By Anirban Nag
LONDON, Aug 13 (Reuters) - Sterling edged up in early European trade on Wednesday as investors trimmed bets against the currency before a Bank of England report, which may give clues on when the UK will start to tighten monetary policy.
The euro struggled near recent lows while the yen fell against the dollar, digesting data that showed Japan's economy contracting in the April-June quarter.
Sterling edged up 0.1 percent against the dollar to $1.6825 , pulling away from a two-month low of $1.6757 struck on Tuesday. It also rose against the euro, with the single currency easing by 0.2 percent to trade at 79.38 pence.
The Bank of England's Inflation Report, which will include updated economic forecasts, is likely to provide a fresh steer on the BoE's intentions for rate hikes. The bank has said before that rate hikes, when they happen, will be data driven and gradual.
Wage data - a driver of inflation and an indicator of how much slack remains in the labour market - is due before the Inflation Report and could prove important.
Still, given the pound has fallen in recent weeks and rate hike expectations have more or less remained stagnant, traders said there was a risk that the British currency could rise if the report is hawkish and inflation forecasts are on the higher side.
"We think that the balance of risks is skewed towards some sterling strength," said Petr Krpata, currency strategist at ING. "Indeed, market expectations of the further path of UK interest rates have stalled recently, leaving room for catch-up should we get some hawkish hints. We think the market is under-pricing the future path of UK interest rates."
While the market expects Britain's improving economy will prompt a rate hike in the first quarter of 2015, the euro is being dragged down by recent poor economic data which does not bode well for the euro zone recovery.
The euro eased 0.1 percent against the dollar to$1.3351. On Tuesday, the single currency had dipped to $1.3336 after German analyst and investor morale plunged as the crisis in Ukraine took a toll. That put it within a whisker of a nine-month trough of $1.3333 set last week.
Sim Moh Siong, FX strategist for Bank of Singapore, said the euro is likely to lose more ground given the recent weakness in euro zone economic data and the potential for further monetary easing by the European Central Bank.
"I think the trajectory (for the euro) is still downwards. It's just that in the near term, there's a bit of caution in terms of positioning," Sim said, referring to a build-up in bearish bets against the euro.
Japan's economy shrank an annualised 6.8 percent in the second quarter, suffering its biggest contraction since the devastating March 2011 earthquake and tsunami as a sales tax hike took a heavy toll on household spending.
The annualised contraction in gross domestic product, however, was slightly less than forecasts for a 7.1 percent drop.
The yen showed limited reaction to the data initially but slipped in European trade. The dollar rose 0.2 percent to 102.45 yen, having traded between 103.15 yen and 101.51 yen over the past couple of weeks.
The yen held steady against the euro, though. The euro stood near 136.69 yen, staying above an 8-1/2 month low of 135.73 yen touched last week.
(Additional reporting by Masayuki Kitano; Editing by Susan Fenton)
- Europe News