* Sterling supported by real money, Asian investors
* May pull back as patchy UK recovery view to weigh
* Euro off two-month lows vs sterling on China report
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LONDON, May 26 Sterling held firm near two-week highs against the U.S. dollar on Thursday, helped by real money and Asian investors, but gains are likely to be capped by expectations of an uneven UK recovery and steady interest rates.
Against the euro, the pound slipped from two-month highs struck the previous session, with the single currency gaining 0.5 percent to 86.92 pence EURGBP=D4. Near-term resistance was at Wednesday's high of 87.16 pence, with support at 86.735 pence, the May 12 lows.
The common currency EUR= made broad gains on a report that China is interested in buying 'bailout bonds' for Portugal. That also helped the euro recover from a two-month low of 86.32 against the pound hit on Wednesday, although sentiment towards the common currency was still fragile given concerns about Greek debt and the risks of contagion.
Sterling GBP=D4 was up 0.2 percent at $1.6306, having hit a two-week high of $1.6336 earlier in the session. It got a boost from a Citi/YouGov survey which showed UK inflation expectations for the year ahead rose slightly in May after falling in April. [ID:nLAH006873]
Still, higher inflationary expectations are unlikely to push the Bank of England to raise rates, with the majority of policymakers more worried about slowing activity.
A private sector survey on Thursday showed companies in Britain's consumer service sector expect levels of business and profitability to fall more sharply in the next three months.
The Confederation of British Industry's survey reinforced the bleak outlook for household spending. [ID:nLDE74O0ZN]
Data on Wednesday confirmed that Britain's economy made a sluggish start to the year as household spending saw its sharpest quarterly fall in almost two years, backing the view that UK interest rates are unlikely to rise soon.
"The risks for sterling are on the downside," said Kit Jukes, currency analyst at Societe Generale. "The Bank of England will keep an eye on activity data next week which could include some weak PMI numbers. The GDP components on Wednesday also showed some weakness."
The construction sector purchasing managers' index (PMI) will be released on June 2, while the more influential services' sector PMI data will be released on June 3. ECONGB
Financial markets have been steadily paring back their views on the likelihood of a Bank of England rate hike BOEWATCH. Latest pricing shows investors are fully factoring in a quarter percentage point rate hike in February next year, having priced in a similar move for January earlier this month.
In contrast, investors are pricing in a quarter percentage point rate hike by the European Central Bank ECBWATCH in November, despite the euro zone peripheral debt problems.
BNP Paribas said in a report that in the UK's case, the significance of euro zone contagion was quite high, given the current stagflationary macro environment and a banking system still reluctant to expand credit.
It added that UK's banking system would be hurt by the euro zone contagion and recommended entering a short sterling trade against the safe-haven Japanese yen. Sterling/yen GBPJPY=R was trading flat on the day at 133.50.
"GBP/JPY is attractive on this basis, since any intensification of euro-peripheral concerns that sees risk appetite take a deeper hit would see the yen strengthening in its own right," the report said. (Editing by Hugh Lawson)
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