Sterling hits one-week low as dollar rallies across board

(Updates with UK data, adds quote)

By Jemima Kelly and Anirban Nag

LONDON, Sept 9 (Reuters) - Sterling hit a one-week low against the dollar on Friday and registered its first week of losses in four, as the dollar rallied broadly on revived expectations that U.S (Other OTC: UBGXF - news) . interest rates will be hiked soon.

The pound went on a winning streak up to Tuesday, when it hit a seven-week high of $1.3445 after rallying more than 4 percent in the previous two weeks, leaving it more than 5 percent up from a three-decade low plumbed in July.

But it has since fallen around 1.5 percent, dampened by data showing UK manufacturing posting its biggest drop in a year and after Bank of England Governor Mark Carney kept the option of further monetary easing on the table.

It fell 0.4 percent on Friday to hit $1.3239, its lowest in a week, after a U.S. Federal Reserve official said gradual rate increases might be in order and low interest rates were raising the chance of an overheated economy.

Money markets moved to price in as much as a 1 in 3 chance that rates will be hiked later this month, according to CME FedWatch, up from a less than 1 in 5 chance earlier in the day.

The dollar was also bolstered by rising U.S. Treasury debt yields, which rallied on the bank of higher European yields.

"Broadly higher interest rates do appear to be weighing on global markets - there is a risk-off mood in the air," said Societe Generale (Swiss: 519928.SW - news) currency strategist Alvin Tan. "After the ECB being reluctant to act yesterday, the market is maybe feeling that central banks aren't going to be as supportive any more."

Tan added that after such a strong rally, the pound was due a correction, and that some caution was creeping in ahead of next week's Bank of England policy meeting as well as a string of UK data that should offer clues on how the economy is faring after June's vote to leave the European Union.

Against the euro, which was also weaker against the dollar, the pound was flat at 84.635 pence.

Earlier, the pound had traded around $1.33, after data showed the country's yawning trade gap shrank in July.

Analysts said the shrinking trade gap bolstered hopes that external trade would make a positive contribution to overall growth in the third quarter and added to evidence of the economy's resilience.

"The weak pound is making British exports a lot more competitive, which was one of the chief economic benefits promised by many Brexiters before the referendum," said Neil Wilson (Oslo: WILS.OL - news) , analyst at ETX Capital.

"However it's important to note...the very close correlation of import and export prices for the UK, which ought to limit the positive impact of a weak pound longer term." (Editing by Dominic Evans and John Stonestreet)