Sterling set for first daily fall vs euro in two weeks

* Euro stronger after German inflation data

* UK mortgage approvals fall short of expectations

* UK government bonds rally

By Jemima Kelly

LONDON, Sept 29 (Reuters) - Sterling was set for its first daily fall against the euro in two weeks on Monday, after data showed German inflation steadying in September and price rises slightly picking up speed in two German regions.

Flash numbers for the euro zone as a whole due on Tuesday are expected to show inflation slowing to 0.3 percent this month, from 0.4 percent in August - well inside the European Central Bank's "danger zone" of below 1 percent.

But Monday's data from the euro zone's biggest economy could be seen by some as an indication that overall inflation for the bloc could also have remained steady in September.

"Some of the (regional German) data showed a little pick-up in inflation on a year-on-year basis, and maybe that has created a little bit of nervousness ahead of tomorrow's euro zone measure," said Daragh Maher, a currency strategist at HSBC.

The pound has gained over 2 percent in the past two weeks against the euro, as investors have bet on increasingly divergent interest rate paths between Britain, where growth is picking up, and the faltering 18-nation European bloc.

The single currency fell below 78 pence for the first time in over two years on Thursday after Bank of England Governor Mark Carney said a rise in interest rates was "getting closer".

The euro managed to stay above that level on Monday, up a touch at 78.095 pence on the day.

Against the dollar, the pound was steady at $1.6246.

Earlier, sterling was given a little knock by data that showed British mortgage approvals fell more than expected in August, which added to signs that the housing market is coming off the boil.

The Bank of England, which has been taking steps to cool the property market, said there were 64,212 mortgage approvals last month, the weakest figure since May.

Earlier this year Carney said housing was the biggest domestic threat to Britain's economic recovery, given the risk of borrowers taking on too much debt.

"The BoE might be quite happy that the housing market has consolidated a little bit; it makes worries about financial stability a bit less troublesome," said Paul Robson, a foreign exchange strategist at RBS (LSE: RBS.L - news) .

GILTS

British government bonds rallied, outperforming German government bonds on the back of BoE purchases and end-of-quarter buying by funds.

Yields for five-, 10- and 30-year gilts fell by 4 basis points on the day, with five-year yields touching their lowest since Sept. 11 at 1.769 percent.

Ten-year gilt yields fell to 2.43 percent by 1430 GMT, and their spread over Bunds tightened by 2 basis points versus Bunds to 147 basis points.

Vatsala Datta, a strategist at Royal Bank of Canada (Toronto: RY-PC.TO - news) , said gilts were benefiting from the start of two weeks of BoE reverse auctions, as well as end-of-month buying as index-tracking bond funds rebalance their portfolios.

"Since the morning the price action has been driven by month-end factors and the reverse auctions," she said.

The BoE will use its reverse auctions to buy 9.6 billion pounds ($15.58 billion) of gilts to replace gilts that have matured from the 375 billion pound portfolio it amassed under its 2009-12 quantitative easing programme. (Additional reporting by David Milliken; editing by Keiron Henderson)