* Dovish Fed dents dollar, sterling may target $1.5775
* QE risk, euro short-covering may keep it weak vs euro
* UK economy a worry; CBI retail sales survey at 1100 GMT
By Jessica Mortimer
LONDON, Jan 26 (Reuters) - Sterling rose to a one-month high against a broadly weak dollar on Thursday after the Federal Reserve said it would keep rates near zero until at least late 2014 and may opt for more stimulus.
The U.S. central bank’s unexpectedly downbeat tone enabled sterling to recover after losing ground the previous day as data showed the UK economy contracted in the fourth quarter and the Bank of England hinted at more quantitative easing.
However, analysts said the risk of the UK slipping into recession and expectations the BoE will increase asset purchases under its QE programme in February were likely to keep the pound under pressure against currencies other than the dollar.
Sterling rose 0.2 percent to hit a high of 1.5700, its strongest since Dec. 23. Further gains could see it target the Dec. 21 high of $1.5775, though traders cited offers above $1.5700 that could limit its rise in the near term. It was last at $1.5689.
“After (Fed Chairman Ben) Bernanke made it clear the Fed was considering further asset purchases there’s been a very significant sell-off in the dollar and all other currencies have benefited,” said Michael Derks, currency strategist at FXPro.
“Sterling has strongly rejected any move below $1.54 on a couple of occasions and we might see it continue to go a little higher, but above $1.58 it will struggle”.
Against the euro, however, he said sterling was likely to stay weaker as worries about the UK economy and the prospect of further monetary easing grow while market participants trim extremely short positions in the euro.
The euro was down 0.1 percent at 83.55 pence, though it stayed within sight of a near four-week high of 83.91 pence hit earlier this week.
The euro has recovered since hitting a 16-month low of 82.22 pence on Jan. 9, though euro gains may be tempered by concerns about the risk of the euro zone debt crisis deepening.
“83.90 (pence) is the key level on the euro/sterling upside with stops likely to be located above there,” Lloyds analysts said in a note to clients.
Britain’s economy shrank by 0.2 percent in the last quarter of 2011, below the consensus forecast for a 0.1 percent contraction.
The weak data increased the chances of more easing from the Bank of England, as minutes to this month’s meeting of UK policymakers showed the central bank edging closer to pumping more money in order to aid a faltering economy.
“With high export exposure into a quickly slowing Eurozone, weak productivity, and the potential for more easing from the BoE in the imminent future, sterling’s prospects look bleak, in our view,” Morgan Stanley analysts said in a note to clients.
They added they would use higher levels in sterling/dollar to re-establish bearish strategies.
The Confederation of British Industry’s distributive trades survey is due at 1100 GMT and a weak reading could add to concerns about economic weakness. The reported retail sales balance is seen at -6 in January from +9 in December.