* Sterling extends gains versus euro, flat against dollar
* UK gilt yield hits fresh 2-year highs
* Improving UK data could see sterling rise further
LONDON, Aug 29 (Reuters) - Sterling rose against the euro on Thursday, recovering from recent three-week lows and helped by elevated bond yields after the Bank of England chief showed no immediate concern about their impact on the economy.
The benchmark 10-year gilt yield hit a fresh two-year high of 2.827 percent while its gap with the German 10-year bund yield widened to a new three-year high. While the 10-year yield slipped to 2.79 percent in afternoon trade, the spread was enough to give the pound a boost versus the euro.
The euro was down 0.65 percent against the pound at 85.37 pence, having hit a three-week high of 86.51 pence on Wednesday. The pound has risen 2.3 percent against the euro so far this month.
Against the dollar, sterling was down 0.1 percent at $1.5515, but it outperformed most major currencies like the euro, which fell 0.7 percent against the dollar.
The dollar was also 0.6 percent firmer against the yen and a basket of currencies after data showed the U.S. economy accelerated more quickly than expected in the second quarter and latest weekly jobless claims fell.
The steady rise in UK money market rates and yields has supported the pound, which is up 2 percent against the dollar this month.
“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 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 expect the BoE may have to hike rates much earlier than it has flagged.
Bond prices recovered from earlier losses and were higher on the day as some investors bought at lower levels.
Despite the recovery, bonds are probably headed lower following Carney’s announcement that banks will be able to reduce their liquidity buffers, analysts said. Banks bought billions of pounds of bonds in 2009 and 2010 to comply with tighter rules.
The relaxation could see banks pare gilts holdings and increase funding to the productive sectors of the economy, boosting growth.
“The lack of any discussion of quantitative easing in the speech left little reason for investors to rethink bearish views on the gilt market,” said Henry Skeoch, fixed income strategist at Barclays. “Comments on bank liquidity buffers in the speech were also negative for gilts.”