Sterling hits 2-month low vs dollar on Greece, Spain concerns

LONDON (Reuters) - Sterling hit two-month lows against the dollar on Friday as a string of downgrades to Spanish banks and a cut in Greece's credit rating increased investor appetite for the safe-haven greenback.

But the growing worries about the risk of euro zone break-up, cited by Fitch as a factor in its sovereign downgrade on Greece, drove the pound higher against the single currency.

Sterling weakened against the dollar to $1.5732 after 16 Spanish banks were downgraded Moody's late on Thursday. That further dented risk appetite after reports - denied by the government - of a run on the country's fourth largest bank Bankia weighed on sentiment.

It recovered to $1.5795 as some investors cut bearish positions, although given the UK's strong trade links and its banking sector's huge exposure to the euro zone, sterling was likely to ease further against the dollar, traders said.

The euro fell against the pound to 80.25, partly reversing a rise over the past two sessions after it hit 3-1/2 year lows at 79.50 pence on Wednesday.

Investor attention is switching to a U.S.-hosted G8 summit at Camp David at the weekend, at which world leaders will seek to address the chronic debt problems in the euro zone and the political stalemate in Greece.

"We are looking for anecdotal evidence from the G8 meeting on how do deal with the Greece situation but our expectations are pretty low for any progress ...We are looking for more risk-off conditions with the dollar streaking ahead," said Richard Driver, strategist at Caxton FX.

The political uncertainty in Greece led Fitch to cut the country's debt to CCC from B- on expectations that it could soon leave the euro.

QE OR NOT QE

The Bank of England's quarterly Inflation Report released on Wednesday left the door open for further quantitative easing, sapping investor appetite for the pound.

Bank of England policymaker Adam Posen said in an interview on Friday he may have been premature in dropping his call for additional stimulus last month, because the underlying economy may be weaker than he thought earlier this year.

Posen has been a dove in the BOE's monetary policy committee but recently dropped his call for asset buying, giving a huge boost to the British pound. More QE is usually considered negative for the currency.

Some analysts expect modest consolidation in the euro against sterling after the single currency lost ground for four straight weeks.

"The single currency appears to have found some support around the 79.50 pence level...the November lows of 78.45 remain the longer term target but we may see some consolidation first," CMC Markets told clients in a research note.

(Editing by John Stonestreet)