LONDON - The pound headed on Friday for its best monthly performance against the dollar this year, driven by expectations that the Bank of England may need to keep UK interest rates higher for longer as inflation persists.

Data on Friday showed UK house prices rose in May after two months of declines, although a separate report later in the day on U.S. inflation could prove a bigger driver for currencies.

Sterling was down 0.12% on the day at $1.2717, but was headed for a rise of 1.7% in May, which would be its largest monthly increase since November's 3.9% gain.

The pound hit a two-month high of $1.2801 on Monday and has drifted since then to a low around $1.268. But analysts say any further declines should remain relatively contained.

"While these levels underpin (sterling), further range-trading is likely to be witnessed. A drop below these lows would engage the April-to-May tentative uptrend line at $1.2628," IG senior financial analyst Axel Rudolph said.

Traders expect one rate cut this year from the Bank of England, but the jury is out on whether there is scope for a second. Interest-rate futures show roughly 32.5 basis points' worth of cuts are priced in by December, down from just over 50 bps a week ago.

Investors tend to watch how sterling performs against the euro for a more accurate reflection of sentiment towards the UK economy and its markets.

The euro headed for its largest daily jump against the pound on Friday since early May, after data showed euro zone inflation picked up more than forecast, with less than a week to go until the European Central Bank is expected to deliver a rate cut.

The euro was last up 0.22% at 85.23 pence, but was still on course for a third successive monthly decline against sterling and for a yearly drop of 1.6%.

Later in the day, data is expected to show the U.S. personal consumption expenditures (PCE) index, excluding food and energy prices, rose 2.8% in April, matching the increase in March. Month-on-month, core PCE is expected to have risen 0.3%, according to a Reuters poll.

(Reporting by Amanda Cooper; Editing by David Holmes)