* Euro set for smallest week of gains in 10 months
* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh
By Saikat Chatterjee
LONDON, April 20 (Reuters) - The euro weakened below $1.23 on Friday and is poised for its biggest weekly drop in two months as investors trimmed record high bets before a European Central Bank meeting next week where policymakers are largely expected to signal no change in policy.
Commodity currencies such as the Australian dollar and the Kiwi came under pressure thanks to a drop in Chinese stocks, while sterling extended losses for a second consecutive day after the central bank dampened expectations of a May rate hike.
Long euro bets are the biggest consensus trade in the foreign exchange market, with net positions holding near a record high despite PMIs recording a sizeable drop in March and mixed inflation data.
"We are seeing the euro stuck in a range and unless the ECB signals a major change in policy we expect the currency to be trapped around these levels," said Kenneth Broux, an FX strategist at Societe Generale in London.
The European Central Bank meets next week and expectations have grown that policymakers may take another small step in exiting its ultra-easy monetary policy after dropping a long-standing pledge to increase its bond buying if needed at its last meeting in March.
But Nordea markets strategists believe such a step may be hasty, given some signs of a softening in economic data and brewing concerns of an escalation in trade disputes.
The central bank still wants to emphasise patience, prudence and persistence", they said in a note. "Forward guidance will thus likely be left unchanged next week, while Draghi’s tone should be relatively dovish."
Despite a 0.4 percent drop to $1.2299 on Friday, the single currency has traded within a broad 1.21 to 1.25 range for much of this year even as long euro positions have swelled to a record $23 billion.
The Australian dollar came under heavy selling pressure as a drop in Chinese stocks weighed on the currency despite generally firmer commodity prices across the board. The Aussie weakened half a percent while the kiwi weakened 0.7 percent. Shanghai stocks ended down 1.5 percent.
Sterling took another leg down on Friday to $1.4041 having fallen nearly 1 percent in the New York session after Bank of England Governor Mark Carney said that a rate hike this year was "likely".
"There is a vulnerability in the British economy which Carney is only flagging now when markets have all but priced in a May rate hike," said Marc Ostwald, a global strategist at ADM Investor Services International in London.
"This is a bit like indicating north by northwest and then choosing to fly south by southeast."
Expectations of a UK interest rate increase in May has shrunk to around 40 percent from 70 percent earlier this week after Carney's remarks.
The dollar held generally firm across the board helped by higher U.S. Treasury yields. Ten-year yields held at 2.91 percent.
The dollar firmed to 107.54 yen, up 0.2 percent on the day and edging near its seven-week high of 107.78 yen touched last week, after U.S. President Donald Trump apparently made no new fresh demands on trade at his meeting with Japanese Prime Minister Shinzo Abe earlier this week.
Elsewhere, the euro stabilised below the 1.20 line against the Swiss franc after briefly breaking above that line on Thursday.
Reporting by Saikat Chatterjee; Additional reporting by Hideyuki Sano in TOKYO; Editing by Alison Williams