Sterling drops to three-week low vs dollar on growth, trade worries

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By Patrick Graham

LONDON, May 28 (Reuters) - Sterling fell on Thursday after data confirmed the British economy grew 0.3 percent in the first quarter compared with the quarter before, disappointing many who had expected a bigger gain.

The pound has been holding firm in the three weeks since Britain's Conservatives won a surprise election victory, and for now seems subject to external factors like the dollar's year-long rally and problems in the euro zone.

But there were worrying signs for some investors in the data. A sharp rise in imports worsened the net trade position for the United Kingdom, which already runs a large current account shortfall.

"Like us, the Monetary Policy Committee expected to see the initial estimate of first-quarter growth to be revised up, but the weakness in net trade was a notable headwind," said Sam Hill, senior economist at RBC Capital.

"On the export side, this may be due to the reversal of a very strong performance in the previous quarter. However, together with the more significant effect of strong import growth, the scale of the trade deficit could be a signal that sterling's appreciation is having its influence on domestic activity."

He added a strong currency - on a trade-weighted basis sterling hit a seven-year high last week - could be a drag on growth and push back a rate increase by the Bank of England.

The pound was down 0.5 percent against the dollar at $1.5260, its lowest since May 8. The euro was up almost half a percent at 71.38 pence per euro, its strongest in a week.

On the horizon is a battle over whether to keep Britain in the European Union, a potential threat to investment and growth that analysts say has yet to hit sterling seriously.

"There are significant risks to expectations on UK growth from all the noise around the referendum," a trader with a London-based fund said. "I would be astonished if the Bank of England delivered the higher interest rates that people have been betting on over the past two years any time soon." (Additional reporting by Anirban Nag and Jemima Kelly; Editing by Larry King)