Sterling hits 1 1/2-mth low vs rallying euro

* Sterling hits 84.58 pence per euro, weakest since June 1 * Losses vs euro drag sterling down vs dollar * Stg/dlr supported after closing above key tech level

By Naomi Tajitsu

LONDON, July 16 (Reuters) - Sterling fell on Friday, hitting its lowest level against the euro since June 1 as rising European money market rates and higher equities stoked demand for the single currency.

Better-than-expected U.S. corporate earnings this week, including from Bank of America (BAC.N) and General Electric (GE.N) on Friday, have also helped to stoke demand for higher-risk currencies, which has benefitted the euro. [ID:nN16144753]

The pound's losses versus the euro helped to pull it away from a 2 1/2-month high hit against the dollar the previous day, but losses were limited after the UK currency closed decisively above a key technical level on Thursday.

Analysts said sterling's slide versus the dollar, which clips a three-day winning streak, suggested that investors are taking a breather from the pound's dramatic rise since mid-May as speculators unwind extreme short positions in the currency.

"Positive news on U.S. bank profits and rising rates in the euro zone had added to the recent 'dollar-off' sentiment, of which the euro was a beneficiary," said Peter Frank, currency strategist at Societe Generale.

He added: "People are a bit nervous about their cable positions, there's obviously been a big reduction in cable shorts this week."

In past weeks, deteriorating sentiment towards the dollar has been a key factor behind sterling's short-covering rally, which began in mid-May.

Market participants said that thin, seasonal liquidity in currency markets was helping to exacerbate sterling moves.

By 1419 GMT, the euro EURGBP=D4 was up 0.8 percent on the day at 84.37 pence, having rallied as much 1.0 percent to 84.58 pence, its strongest since June 1. It is poised to end the week 0.7 percent higher.

The single European currency rose broadly on Friday, as the recent rise in euro-priced bank-to-bank lending rates picked up pace, pushed on by the sharp drop in spare European Central Bank cash in money markets. [ID:nEAP000481]

This helped to lift the currency above 84.38 pence, the 50 percent retracement of the euro's peak-to-trough move between May and June.

Technical analysts said the next key level was 84.80 pence, the 38.2 percent Fibonacci retracement of the euro's slide from a high hit in March to the June low.

LESS VULNERABLE STERLING?

Sterling GBP=D4 fell 0.7 percent to $1.5344, pulling away from $1.5473 hit on Thursday, its strongest since late April.

Support was seen at $1.5310 -- the trendline drawn through highs hit in November 2009 and January 2010. Its close above that level on Thursday was seen opening the way to $1.5525, a high last hit in April.

Sterling has benefitted this week from data showing a significant fall in the number of people claiming UK unemployment benefit in June, which has raised optimism that an improving labour market will support the economy's recovery.

This contrasted with a series of sluggish U.S. economic reports, including a drop in wholesale prices in June and a slowdown in manufacturing announced on Thursday. That data has raised concerns that the U.S. recovery may be slackening.

Analysts said sterling would extend near-term gains on expectations the UK economy would ultimately benefit from tough spending cuts planned by the new coalition government, while negative dollar sentiment would provide an additional boost.

"There are worries about the UK economy in the second half of the year but there's respect for the fiscal austerity that the new government is going to put in place," Michael Derks, chief strategist at FXPro, said.

"People don't feel as vulnerable about sterling, and I think that's unlikely to change in the coming weeks." (Editing by Susan Fenton)