Sterling hits 2-week high after improved output data

(Adds more comment, BoA Merrill Lynch report, updates prices)

By Patrick Graham

LONDON, Oct (HKSE: 3366-OL.HK - news) 7 (Reuters) - Sterling rose to its highest in more than two weeks against the dollar after data on Wednesday showed industrial output had recovered better than expected from a July slump, pushing the pound back above $1.53.

The output reading added to a mixed bag of recent data and policy signals for the pound which has seen investors roll back expectations for a first rise in Bank of England interest rates far into next year.

Some players said that shift had been overdone - and that and the output figures contributed to a more positive mood on the pound and rises in gilt yields on Wednesday.

"European fixed income has been underperforming today. In combination with the better industrial production numbers, we have seen gains in sterling, particularly against the euro as a result," said Nick Sgouropoulos, a currency strategist with Barclays (LSE: BARC.L - news) in London.

"Ahead of the Bank of England meeting tomorrow, our view is that the rates market has gone too far in pushing back expectations of a rise next year. So the risks for euro-sterling are to the downside."

By 1522 GMT, the pound had gained 0.6 percent on the day at $1.5325. It (Other OTC: ITGL - news) gained 0.75 percent against to 73.46 pence per euro.

Sgouropoulos said Barclays analysts were looking for a fall for the euro to 70 pence by the end of the year, driven by their expectations of more quantitative easing by the European Central Bank.

Another major house concerned that money markets have taken a step too far on pushing back expectations of a UK rate rise was Bank of America Merrill Lynch, although they were less sure about extending that to a more bullish view on the pound.

The bank's analysts said the risks to sterling ahead of Thursday's policy meeting were "asymmetric" but still held risk for sterling.

"Although the market has pushed back its timing for the first rate hike into 2017 a downbeat assessment by the Bank of England and the risk of a 9-0 vote could still lead to further GBP pressure," they said in a note.

Sterling's gains this year on the back of expectations the BoE was one of the few central banks even considering raising interest rates have made it among the most exposed to growing worries over world growth.

The UK economy is still doing better than others: domestic output numbers topped forecasts in both monthly and annual terms but compared with August last year, manufacturing output was down 0.8 percent.

Analysts from Societe Generale (Swiss: 519928.SW - news) identified bets on sterling weakness against the dollar as one good way to hedge against another round of global economic nerves and a drift into a lost decade of little or no growth.

"Overall, short GBP/USD and short NZD/USD are sensible strategies to hedge the risk of further weakness in EM and China, especially in the 'hard landing' scenarios," they said. (Reporting by Patrick Graham and David Milliken; Editing by Andrew Heavens and Gareth Jones)