Sterling gains as dollar slips

LONDON (Reuters) - Sterling strengthened against the euro and dollar on Wednesday, lifted by a broad slide in the dollar and as dealers adjusted positions ahead of the Bank of England's interest rate decision on Thursday.

The dollar, digesting Barack Obama's victory in the U.S. presidential election, lost ground after a fall in dollar interbank rates and spreads showed money market strains may be easing, taking the pressure off recent demand for dollars.

Sterling benefited, even though the outlook for the UK economy remained bleak: UK shares fell 2 percent, data showed the British service sector shrinking at its fastest pace in 16 years and traders braced for a steep cut in UK interest rates.

Futures markets attached around a 40 percent probability the Bank of England will cut rates a full percentage point to 3.5 percent, which would reduce the gap in borrowing costs between the UK and the U.S., where rates stand at 1 percent.

This might typically dent the pound. But some analysts say bold steps from the Bank will curb the impact of the recession most say is looming.

"The market seems ready to reward proactive central banks, and it would appear that both banks will cut rates by at least 50 basis points," said Audrey Childe-Freeman, currency strategist at Brown Brothers Harriman.

"There are a series of negative forces weighing on sterling, but we've come a long way already. The question at this point is how much bad news has already been priced in, and whether we may see a bit of consolidation before the negative trend resumes," she added.

By 4:00 p.m. sterling was up by around 1.25 percent against the dollar at $1.6158, according to Reuters data.

The euro was down 0.8 percent at 80.70 pence, and the pound was up 1 percent against the yen at 160.65 yen.