* UK economy contracts 0.7 pct during Q2
* Data well below forecasts for 0.2 pct fall
* Pound slips, seen vulnerable to more losses
* Euro crisis means falls vs euro may be limited
By Jessica Mortimer
LONDON, July 25 (Reuters) - The pound fell on Wednesday after data showed the British economy contracted by more than three times the rate it was expected to in the second quarter, increasing the prospect of more monetary easing by the Bank of England.
Gross domestic product fell by 0.7 percent in the three months to June, its biggest decline since the height of the financial crisis in early 2009. Forecasts had been for a drop of just 0.2 percent.
It marked the third consecutive quarterly fall in output, causing the pound to drop to a 12-day low against the dollar and to lose around 1 percent against the euro, pulling it away from a 3-1/2 year high reached on Monday.
Analysts said sterling could be vulnerable to more falls as the market starts to price in the prospect of further quantitative easing or even a cut in interest rates by the BoE.
“Going forward there is a risk that the situation in Europe continues to deteriorate, which will have a negative impact on the UK ... We could see the pound trading more negatively,” said Lee Hardman, currency economist at BTMU.
“The risks (for the data) were to the downside but the extent of the weakness was somewhat shocking,” he said, adding he expected the pound to fall below $1.50 in the next 3-6 months.
The euro rose to a 6-day high of 78.54 pence, well above Monday’s trough of 77.56 pence, its weakest since late 2008. It was last up 0.7 percent at 78.33 pence.
Against the dollar, the pound fell to as low as $1.5459 and more losses would see it target its July 12 trough of $1.5393.
“The data begs the question that if the UK is one of the weakest major economies out there then should euro/sterling be heading towards 77 pence?” said Chris Turner, head of currency strategy at ING.
He said sterling could fall to around $1.52 or $1.53 against the dollar, although ING were for now leaving their forecast for euro/sterling at 75 pence unchanged.
Most analysts do not expect sterling to stray too far from its recent high against the euro. As fears grow about whether Spain will need a full bailout and whether Greece will leave the euro, many analysts expect sterling will still be scooped up by investors seeking alternatives to euro zone assets.
Paul Robson, currency strategist at RBS, said the euro could squeeze higher against the pound if the market starts to price in an increasing probability of a cut in interest rates from their current record low 0.5 percent in the coming months.
“Valuations start to look a bit stretched this far below 80 pence,” he said.
The figures will intensify concerns the UK could struggle to meet its targets for cutting the deficit and prompted UK finance minister George Osborne to say the economy had “deep-rooted” problems.
The government’s determination to cut Britain’s debt through a programme of harsh austerity measures has broadly lifted the pound. However, economic weakness could put a dent in these plans as it offsets the benefits of spending cuts.
Offering a glimmer of hope, however, a survey pointed to resilience in the UK manufacturing sector, with factory orders stronger than expected in July, though sterling showed little reaction. (Editing by Nigel Stephenson and Patrick Graham)