* Manufacturing activity slows from record pace in February
* Sterling near five-month low versus euro EURGBP=D4
* Interest rate outlooks leave pound vulnerable
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By Neal Armstrong
LONDON, April 1 Sterling fell on Friday after a survey of British manufacturing activity growth weakened in March, with the pound vulnerable to further falls on relative interest rate outlooks compared with the euro zone and the United States.
Traders said flows were relatively light as markets prepared for the release of the latest U.S. employment report at 1230 GMT.
British manufacturing activity growth weakened more than expected in March after the inflow of orders slowed sharply, but firms still ramped up prices at a record rate to cover rising costs, a survey showed on Friday. [ID:nSLAVEE7S1]
The figures highlight the dilemma facing Bank of England policymakers over how to tackle persistently above-target inflation without harming a fragile economic recovery, but will reinforce expectations it will leave rates on hold in May.
"Although output prices continued to rise, a further decline in the input price index will be welcome news for the Bank of England, and could be signalling the start of waning inflationary pressures," said Hetal Mehta, economist at Daiwa Capital Markets.
Sterling GBP=D4 fell around 60 pips in the wake of the data to hit a session-low of $1.6010 versus the dollar.
It was within sight of a two-month low of $1.5937 hit last month. Technical analysts were looking for a daily close under the February lows at $1.5963 to open up further downside potential for the pound.
The euro EURGBP=D4 rose around 30 pips to 88.40 pence, moving back towards a five-month high hit on Thursday of 88.53 when higher-than-forecast inflation in the euro zone cemented expectations for a rise in European Central Bank interest rates as early as next week.
"What we have now is more hawkishness coming out from ECB, more hawkishness coming out from some members of the FOMC. So there's nothing quite so special about the UK's rate outlook, and that's being reflected and eroding the interest rate outlook for sterling," said Kit Juckes, currency strategist at Societe Generale.
The dollar was supported after the Minneapolis Federal Reserve President Narayana Kocherlakota signalled the Fed could raise interest rates by three-quarters of a percentage point by the end of the year. [ID:nN31167243]
Markets expect the Bank of England to raise UK interest rates in July, with another rise factored in by year-end. BOEWATCH (Editing by Hugh Lawson)