(Updates prices, comment)
By Patrick Graham
LONDON, May 22 (Reuters) - A worse-than-expected fiscal deficit and disappointing export data pulled sterling off 5-1/2 year highs against a basket of currencies on Thursday, though it was trading largely flat for most of the day.
Sterling had jetted higher earlier this week on more bullish numbers on the British economy, which is outstripping most of its neighbours in Europe, solidifying expectations of a rise in interest rates early next year.
But a second estimate of first-quarter growth offered no upward revision and little sign of the broadening of sources of growth which would quell doubts over the structure of the recovery.
Gross fixed capital formation growth slowed to just 0.6 percent from 1.9 percent a quarter earlier while trade made a zero net contribution to growth, although business investment was the strongest in a year. The country's public sector net borrowing rose in contrast to expectations of a fall.
"This outturn takes the UK economy one step back in its challenge of external rebalancing," Barclays analyst Armela Mancellari said.
Sterling dipped a third of a percent in response and extended those losses late in the European day to trade at $1.6856. The euro pulled further away from a 17-month low of 80.85 pence, to trade at 81.00 pence, marginally up on the day.
Still, expectations in general for the UK economy remain relatively buoyant and the pound's trade-weighted index fell just 0.1 percent overall, data from the Bank of England showed. It is still up around 2.5 percent on the year.
"While a second estimate of UK GDP printed in line with expectations, it was the weak public sector borrowing data that took markets by surprise," said Alex Edwards, head of the corporate desk at UKForex.
"Investors were heavily buying sterling/dollar heading into the release, and so the surprise number was a good excuse to trim these positions."
The sterling overnight interbank average (SONIA) curve showed investors still price in a chance of a rate rise in nine months' time.
That would make the Bank of England the first major central bank to tighten policy and increase the pound's premium over its peers in Europe and the United States.
The European Central Bank is likely to ease policy next month. And while the Federal Reserve is reining in its policy of money-printing, a rise in interest rates is still sometime away.
"We expect the pound to start regaining support. We expect this to remain evident on many of the crosses initially, with euro/sterling likely to continue to push lower, targeting the 80.30/80.00 area initially," Morgan Stanley said in a note. (Reporting by Anirban Nag; Editing by Angus MacSwan and Susan Fenton)