Sterling at 3-1/2 mth high vs dollar on US, EZ woes

But Britain's own struggles with an patchy recovery, and prospects that the Bank of England could also resort to more quantitative easing is likely to keep a lid on gains.

In an environment where investors are increasingly wary about sovereign debt risks, the pound drew some support from data which showed Britain's public finances posting an overall surplus in July, pushing down overall borrowing this fiscal year and bringing the government closer to its fiscal targets.

Sterling was up 0.6 percent at $1.6614, having hit a fresh 3-1/2 month high of $1.6618. It recovered smartly from a session low of $1.6444, leaving it on target for its best weekly performance since mid-January. It triggered buy stops above $1.6600 on its move higher.

"Given the focus on the euro zone's sovereign debt problems and slowing growth in the US, the focus is off the UK for now," said Lauren Rosborough, currency strategist at Westpac.

"Sterling has outperformed recently, particularly against high-beta currencies like the Australian dollar, not because the UK is doing particularly well but because it's not doing particularly badly."

Mounting fears of a global recession and concerns about rising funding stress facing some large European banks saw global stocks extend a slide. European bank shares fell sharply and these concerns have weighed down on riskier currencies like the Australian dollar.

"Given the renewed demand for safe-haven currencies, sterling has fared quite well," said Michael Derks, strategist at FXPro. "Sterling is the least bad of the big currencies, but economically the country is still completely stuck in neutral."

Traders cited talk the pound has had support from a large M&A deal, with Hewlett-Packard bidding $11.7 for British enterprise search-software maker Autonomy .

SUPPORTED VERSUS THE EURO

Against the euro, it eased, although traders cited offers to sell the common currency at higher levels. Despite its losses, sterling stayed near a 12-week high, boosted by concerns about a worsening euro zone debt crisis.

The euro was up 0.2 percent at 86.96 pence, holding above its 200-day moving average at 86.70 pence and not far from the Aug. 5 low of 86.44 pence, below which would mark its weakest since late May. Traders said offers above 87 pence could check gains.

A weekly close below the 200-day average could prompt further falls, technical analysts said.

Analysts expect sterling to gain against the cyclically sensitive currencies like the euro, but could underperform funding currencies like the yen and Swiss franc as worries about a deep global slowdown take a foothold.

"The sharp ongoing sell-off in UK bank equity prices will also reinforce tight bank lending restraining further domestic demand growth," Bank of Tokyo Mitsubishi said in a note.

"With the government steadfastly committed to fiscal consolidation, the BoE may soon have to respond to intensifying pressure to resume QE to support growth. However with the pound already extremely cheap, further downside may prove relatively limited."

Markets expect the Bank of England to keep interest rates on hold until the end of 2012, with more speculation rising it could opt for further quantitative easing to stimulate growth.

Copyright Reuters, 2011