* Sterling extends gains versus euro, flat against dollar
* UK gilt yield hits fresh 2-year highs
* Improving data could see sterling rise further
LONDON, Aug 29 (Reuters) - Sterling rose against the euro on Thursday, recovering from recent three week lows, helped by rising bond yields after the Bank of England chief showed no immediate concern about their impact on the economy.
The benchmark 10-year gilt yield continued to rise, hitting a fresh two-year high of 2.827 percent while its gap between German 10-year bund yield widened to a new three year highs. That gave the pound a boost versus the euro.
The euro was down 0.5 percent against the pound at 85.49 pence, having hit a three-week high of 86.51 pence on Wednesday. The pound has so far risen 2.3 percent against the euro this month.
Against the dollar, sterling was flat at $1.5520 outperforming most major currencies like the euro which fell 0.6 percent against the dollar. The dollar was also firmer against the yen and a basket of currencies.
The steady rise in UK money market rates and yields has supported the pound, which is up 2 percent against the dollar.
“Sterling and short-term rates may remain supported if markets start positioning for more positive data surprises out of the UK in coming days,” said Valentin Marinov, currency strategist at Citi.
“Focus next week is likely to be on the August PMIs and July industrial and manufacturing production. More evidence of improving business sentiment and economic activity is likely to strengthen the tailwinds for sterling.”
Sterling overnight interbank average rates were still pricing in the chance of a first rate rise in around two years’ time, unchanged from before the BoE chief’s much-awaited speech on Wednesday.
Investors had anticipated Governor Mark Carney would try to talk down the rise in UK money market rates following a run of strong data. But his speech on Wednesday fell short of those who had geared up for a far more aggressive bid to dampen expectations of monetary tightening.
Carney earlier this month issued “forward guidance” on monetary policy, saying interest rates would stay at a record low 0.5 percent until unemployment fell to 7 percent - something he said could take three years.
However, in light of the strong domestic data including better prospects for the jobs market, investors are not convinced it would take that long and the BoE may have to hike rates much earlier than it has flagged.
“The speech was not as dovish as had been feared, and the market continues to look past the forward guidance at the bigger picture of a rapidly improving UK growth profile. We still like euro/sterling lower,” Societe Generale said in a note.
Bond prices also fell and could extend losses due to Carney’s announcement that banks will be able to reduce their liquidity buffers. Banks bought billions of pounds of bonds in 2009 and 2010 to comply with tighter rules. [ID: nL6N0GT2F1]
The relaxation could see banks pare their gilts portfolio.