Pound drops to 2-week low vs dollar as Bank holds rates

LONDON (Reuters) - Sterling fell to a near two-week low against the dollar on Thursday after the Bank of England kept interest rates on hold as expected, as investors who had bet on an outside chance of a hike cut positions.

Traders said more downside stops are positioned below the pound's trough hit on February 25 as some investors pare expectations of aggressive rate hikes by the Bank this year.

The Bank, which left rates at their record low of 0.

"The price action in sterling/dollar and euro/sterling following the rate decision suggests that markets had positioned slightly for the potential of a shock Bank rate hike," said Greg Anderson, currency strategist at Citi.

The Bank made no statement alongside its decision, and the voting pattern will be announced in minutes in two weeks' time. These are likely to reveal a lively debate, given three out of nine policymakers voted for a hike in February.

Sterling was down 1 percent against the dollar at $1.6044, its lowest since February 25 and more than 1 cent below where it was trading prior to the Bank announcement. Traders said more stops are positioned through $1.6025/30 on the downside.

The pound cut earlier gains to trade weaker against the euro with the single currency up 0.2 percent at 85.98 pence.

The euro came under broad selling pressure after a cut to Spain's credit rating by Moody's highlighted the debt problems facing several euro zone countries. But expectations that the European Central Bank will raise rates before the UK central bank supported the euro against the pound.

Analysts are expecting the ECB to raise rates as early as next month, while investors are fully pricing in a first 25 basis points rate hike by the Bank in July.

SOLID UK DATA

UK manufacturing output rebounded more than expected in January, rising by 0.8 percent on the month, its fastest pace in 10 months.

The manufacturing sector has performed well recently, buoyed by strong external demand. It makes up only a small proportion of the economy, however, and there have been signs of fragility in other areas, including the retail and housing sectors.

On Friday, UK producer prices data are due and analysts expect an increase in input prices to drive factory gate inflation higher, keeping alive concerns that price pressures are becoming more permanent in the economy. Input prices are expected to be driven higher by firmer commodity and oil prices.

Most Bank monetary policy committee (MPC) members are expected to want more evidence that the economic recovery has gained momentum this year before opting to hike rates, especially after an unexpected fourth quarter contraction.

"We may see a fourth vote added in favour of a rate rise this month, but I do not envisage the Bank raising rates before June," said Duncan Higgins, senior analyst at Caxton FX.

(Additional reporting by Anirban Nag and Niki O'Callaghan; Editing by Catherine Evans)