Sterling bounces back as markets cheer May appointment

(Adds more comment, BlackRock (Sao Paolo: BLAK34.SA - news) warning on economy)

By Patrick Graham

LONDON, July 12 (Reuters) - Sterling rose along with UK government bond yields on Tuesday as the early anointing of interior minister Theresa May as prime minister fed into a generally improved global mood among financial investors.

The 1.5 percent rise to $1.3186 put the pound on track for its biggest daily gain since Britain's June 23 vote to leave the European Union drove it to 31-year lows.

It also strengthened 1 percent to 84.22 pence per euro , a one-week high, extending gains made on Monday after the withdrawal of leading Brexit campaigner Andrea Leadsom cleared the way for May's formal appointment this week.

"Clarity on the UK's leadership was another factor boosting investors' appetite," said Hussein Sayed, chief market strategist with retail brokerage FXTM.

"However, the big question remains as to when Article 50 is going to be triggered, and how investors are going to react to the UK's official departure from the EU. Meaning that investors shouldn't get overexcited."

This week's main economic event is a Bank of England policy meeting on Thursday which many analysts and investors expect will yield a cut in interest rates to shield the economy from the immediate shock of the Brexit vote.

While 10-year British government bond yields rose 4 basis points to 0.80 percent, two-year yields rose by just over 1 basis point, held down by the expectations of lower official rates.

The pound extended its gains as BoE Governor Mark Carney, two days before the rate decision, told a parliamentary committee that he wanted to make it as clear as possible to households and firms that credit was available.

"We expect the BoE (Shenzhen: 200725.SZ - news) to deliver at least a 0.25 percentage point reduction in their key policy rate at this week's meeting and to signal that more easing is likely when they meet again in August," said Lee Hardman, currency analyst with Bank of Tokyo-Mitsubishi UFJ in London.

"The weak performance of the UK economy and expectations of looser monetary policy from the BoE should keep the pound under downward pressure in the coming months."

While May is seen as a steadier hand than Leadsom to lead Britain into Brexit talks with Europe, some of her stated positions only underline the tensions that have most market analysts predicting weaker UK growth and a weaker pound.

"She (Munich: SOQ.MU - news) has a clear history at least in terms of rhetoric of holding a tough line over wanting to reduce immigration," said Hardman. "That points towards potentially difficult negotiations with the EU and more limited access to the single market for the UK."

Officials from the world's largest asset manager, BlackRock, said on Tuesday that Britain would fall into recession over the coming year and growth in each of the next five years would be at least 0.5 percentage points lower as a result of Brexit.

"Recession is now our base case," the company's chief investment strategist, Richard Turnill, said. "There's likely to be a significant reduction of investment in the UK."

He expected sterling to fall further as the BoE cuts interest rates to zero and expands its bond-buying programme, but not as far as parity with the dollar.

The pound hit a 31-year low of $1.2798 a week ago. (Additional reporting by John Geddie, Jemima Kelly and Jamie McGeever; Editing by Nigel Stephenson and Catherine Evans)