Better-than-expected UK data gives sterling a lift vs euro

By Joshua Franklin

LONDON, March 3 (Reuters) - Sterling rose against the euro on Monday after better-than-expected manufacturing and lending data reinforced growing optimism about Britain's recovery and maintained expectations of an interest rate hike next year.

The monthly Purchasing Managers' Index (PMI) showed British manufacturing grew more quickly than expected in February, while Bank of England data showed UK lenders approved the highest number of mortgages in January since November 2007.

This helped the pound extend gains against the euro into a second week, the single currency down 0.2 percent at 82.34 pence . The euro started the week on a soft note, having lost ground the previous week.

Sterling was down against the dollar at $1.6705 with the dollar helped by a better-than-expected increase in U.S. personal income and spending in January.

Investors will get further clues on the strength of Britain's economy later this week with a string of data to be released. A Reuters poll predicts the dominant services sector to grow at a robust pace in February.

Following a strong run for the pound, however, BBVA (Amsterdam: BBV.AS - news) 's global head of G10 FX, Peter Frank, cautioned that disappointing figures might lead investors to question sterling's strength and the likelihood of the economy achieving the Bank of England's 3.4 percent annual growth forecast.

"There is a risk going forward that the data may give the impression to the market that the Bank of England is too optimistic," Frank said. "If it does that, and we get further weakness in inflation, then I think you could start to get a new lower equilibrium in sterling."

The BoE will announce its latest interest rate decision on Thursday. Investors are pricing in the chance of the first rate hike in the first half of 2015.

"The BoE is likely to remain steady with its monetary policy this week, leaving the pound with a firm tone," Stephen Gallo, currency strategist at BMO Capital Markets, said. "Good bids are likely to be in place between $1.660 and $1.665 in sterling/dollar for the time being."

Indeed, Monday's manufacturing and lending data reinforced expectations the BoE (Shenzhen: 000725.SZ - news) may look to raise interest rates from record low levels some time next year as it shifts focus away from unemployment to a broader range of economic performance.

Citi analysts recommended investors to go long sterling against the Swedish crown for better returns, flagging the prospect of loose monetary policy as a possible drag on the Nordic (SES: MR7.SI - news) currency.

"While activity data has rebounded more recently in Sweden, the central bank continues to battle with disinflation, leaving the door open to further easing," Citi said in a note.

British government bonds tracked moves in Bunds and U.S. Treasuries closely, as prices of safe-haven securities rose with the escalation of the crisis in Ukraine.

The yield on the 10-year gilt was down 4.0 basis points at 1450 GMT to 2.681 percent after choppy trading. Sharp moves corresponded more with news from Ukraine rather than positive British manufacturing and lending data in early trading.