(Updates prices, adds analyst comment)
* Pound steady versus dollar ahead of U.S. non-farm payrolls
* BoE's King warns of threat to UK banks from debt crisis
* Euro/sterling stops cited above 86.20 pence
By Nia Williams
LONDON, Dec 2 Sterling was steady versus the dollar on Friday but looked vulnerable to a fall given concerns the UK economic outlook is worsening as a result of the euro zone debt crisis.
Strategists said warnings by Bank of England governor Mervyn King on Thursday that UK banks should build up capital to insure against the "exceptionally threatening" situation developing in the euro zone added to worries that UK growth could grind to a halt.
Sterling was last trading almost flat on the day at $1.5687, with support seen at the previous day's low of $1.5637.
It remained within sight of the high of $1.5780 hit on Wednesday, when joint central bank action to inject liquidity into the global financial system encouraged investors to sell the safe-haven dollar.
Some market players were reluctant to initiate new positions ahead of U.S. non-farm payrolls data at 1330 GMT. The data is expected to show an increase of 122,000 jobs and a positive surprise could bolster risk sentiment, lifting the pound.
But analysts said developments in the euro zone debt crisis would continue to be the main driver of sterling trade. Any gains made on U.S. jobs data were likely to be short-lived if investors lost faith in European policymakers' ability to solve the crisis.
"Any move we see (on payrolls) is going to be limited. Going into next week the risks are still going to be running very high. There is plenty of disappointment to come from the EU summit which will take the steam out of these moves," said Ian Stannard, European head of FX strategy at Morgan Stanley.
French and German leaders are meeting on Monday to outline joint proposals to put to a Dec. 9 European Union summit, seen as yet another make-or-break meeting for the currency bloc.
GROWTH PROSPECTS DIM
Stannard said the UK banks were likely to engage in a huge amount of deleveraging in coming months, which meant any fresh liquidity measures would probably be absorbed by the deleveraging process rather than driving asset prices higher and supporting the wider economy. The Bank of England restarted its quantitative easing programme in October.
"Sterling is likely to underperform other higher beta currencies and we expect the entire group to underperform the dollar in the medium term," said Stannard.
Sterling had little reaction to PMI data showing UK construction activity expanded last month, though at a slower pace than in October. Construction, which makes up a relatively small part of UK GDP, performed better than the manufacturing sector which shrank at its fastest pace since June 2009.
Many analysts said sterling has been finding support in recent weeks from investors switching out of euro zone government debt into UK gilts.
This trend could change if UK growth collapses and investors start to question the government's ability to repay its debts. Finance minister George Osborne slashed GDP 2012 growth forecasts to 0.7 percent in the autumn budget statement on Tuesday, down from a 2.5 percent forecast in March.
"In the parade of 'ugly' currencies, GBP is looking more and more like it could make a serious challenge for the 'title' in 2012," said BNY Mellon strategist Neil Mellor in a note.
The euro rose 0.15 percent against the pound to 85.92. Traders cited demand from a French bank and said there were stop loss orders above 86.20 pence.
Downside support was seen coming from the 21-day moving average around 85.74. (editing by Ron Askew)