Sterling drops to 4-week low against dollar after strong U.S. jobs data

(Updates after U.S. data, fresh quote, updates prices)

By Anirban Nag

LONDON, March 6 (Reuters) - Sterling fell sharply against the dollar on Friday, dropping to four-week lows after a strong U.S. jobs report, with concerns about a potentially unsettling British election in May also weighing on sentiment.

Sterling was down 1 percent against the dollar at $1.5077 , on track for a drop of some 2.3 percent over the week -- its biggest weekly loss since late 2011.

It was firmer against the euro, though, trading at 72 pence , its highest since December 2007.

The pound's rise against the euro came as interest rate differentials moved in favour of sterling with the European Central Bank gearing up to launch its 1-trillion euro bond buying programme.

The gap (NYSE: GPS - news) between the British 10-year government bond yield and the German 10-year reached its widest since 1997, boosting the pound, traders said.

In afternoon trade, though, the dollar's sharp move took centre-stage. It hit a 11 1/2-year high against a basket of currencies after non-farm payrolls data showed 295,000 jobs in February were added, well above forecasts for an increase of 240,000.

U.S. short-term interest rates futures fell, suggesting markets were looking for the Federal Reserve to raise policy interest rates from near zero as early as this summer.

"All things considered, I think this is a very good labour market report and will only feed into expectations for a rate hike from the Federal Reserve in June. The rally in the dollar immediately after the release clearly supports this view," said Craig Erlam, senior market analyst at Oanda.

The pound losses against the dollar saw it give up ground built in the past few weeks on the back of better economic news in Britain. That has kept alive expectations that a rise in British interest rates could come sooner than expected.

But prospects that an election in May will be unlikely to generate a clear majority for any party and trigger uncertainty in markets, is a risk to those rate hike expectations.

Investors are concerned by the possibility of heavier spending and taxes and more regulation of the financial sector under a possible centre-left Labour government.

They also worry that Britain could leave the European Union if the Conservatives win.

"This election is very uncertain and while sterling's correlation historically to previous elections has not been strong, this time it could be different," said Richard Falkenhall, currency strategist at SEB (Paris: FR0000121709 - news) .

"We think the uncertainty created will see sterling lose ground and forecast sterling/dollar to drop below $1.50 in coming months." (Reporting by Anirban Nag; Editing by Robin Pomeroy)