Sterling retreats against stronger dollar

By Patrick Graham

LONDON, April 21 (Reuters) - Sterling dropped off highs close to $1.50 against a broadly stronger dollar on Tuesday after a week of gains that suggested the pound might have built up resilience to doubts about the outcome of next month's British elections.

Sterling had its best week in almost two years against the dollar last week and the Bank of England's trade-weighted index of its strength against a basket of currencies rose more than 1 percent.

While banks have priced in a rise in volatility in the weeks around the May 7 poll, that performance undermines the idea that sterling will suffer badly in the run-in and during uncertain coalition talks that look set to follow.

"UK election risk now looks fully priced and sterling is close to returning to business as usual," said Richard Batley, an analyst with research house Lombard Street. "We would be most tempted to express that view relative to the euro.

"Investors will be all the more able to brush aside political instability because the UK is currently enjoying stable, consumption-led growth that is not driven by debt. Expectations will persist that the UK will raise rates long before the euro area does."

Sterling fell 0.3 percent against the dollar to $1.4875 but was up by a quarter of a percent at 71.85 pence per euro in morning trade in London.

The euro has weakened across the board this week with Athens stuck in negotiations with its euro zone partners and the International Monetary Fund over reforms required by its lenders to unlock remaining bailout funds and keep it solvent.

Latest polls in the UK show the Conservatives and opposition Labour parties neck and neck, making a hung parliament likely. A strong showing by smaller parties such as the Scottish Nationalists also makes it hard to predict what kind of government can be formed.

Many traders in London's traditionally right-leaning City say a Labour-led government would be a negative. But others worry as much about the prospect of a weak administration that might be unable to deal with Britain's twin deficits, or about the Conservative promise to hold a referendum on whether Britain should leave the European Union.

"The closer we get to May 7th, and whilst the polls remain close, the more sterling will feel the wrath of uncertain investors," analysts from South African bank Investec (LSE: INVP.L - news) said in a morning note.

"The pound will want a quick and functioning result or we could see some downside pressure in the days that follow." (editing by John Stonestreet)