Sterling gains some respite after sharp falls
* Sterling pulls away from 2-1/2 year low versus dollar
* Analysts say sterling still vulnerable to easing prospects
* Weak UK economy, risk of ratings downgrade also weigh
* Could consolidate in very short term
LONDON, Feb 22 (Reuters) - Sterling pulled away from a two-and-a-half year low against the dollar and rose against the euro on Friday as some investors bought it back after its recent decline, though it remained vulnerable to renewed selling.
A couple of UK banks put out a 'buy' recommendation for sterling on Friday, helping the pound. However, any rise is likely to prove temporary, given a grim outlook for the UK and growing evidence that the Bank of England is comfortable with a falling currency as it seeks to rebalance the economy.
So far this year sterling has lost as much as 8 percent against the euro and almost 7 percent against the dollar.
The pound was up 0.1 percent against the dollar at $1.5273, recovering after falling to as low as $1.5130 on Thursday, its weakest since mid-July 2010 and heading for its second straight week of losses. Traders reported offers from $1.5320-50 that may cap any rise.
The euro was down 0.2 percent at 86.24 pence, well below a near 16-month high of 87.645 pence on Wednesday. Reflecting some of the sharp swings in the euro/sterling cross this week, one-month implied volatilities jumped to a 14-month high of around 9.65 percent.
The pound was helped by a drop in the euro after the European Central Bank said banks would pay back 61.1 billion euros of the second of two crisis loans, less than half the amount expected by the market.
A report from the European Commission that forecast the euro zone economy would contract again in 2013 and caution ahead of an Italian election this weekend also weighed on the euro.
"I think the move (in euro/sterling) is done now. We have seen (euro zone money market) rates come down quite a bit and our rate strategists think the move has gone long enough ... this factor is running out of steam for the euro," said Elsa Lignos, currency strategist at RBC Capital Markets.
"Sterling's weakness has been overdone for weeks," she said, adding the second GDP release for the UK would be a key focus in the next week.
Lloyds Bank recommended buying sterling against the Australian dollar. It gave an initial target set at
A$1.5355, citing that the pound had dropped to the bottom of a range of $A1.45-A$1.60 seen in the past couple of years and it was time to buy. Sterling was trading at A$1.4802 on Friday.
RISKS TO STERLING
Still, most traders expect investors would soon resume selling sterling since Bank of England minutes on Wednesday showed policymakers, including Governor Mervyn King edging closer towards more monetary easing. This came after the bank's quarterly report last week said policymakers were prepared to tolerate higher inflation as growth remains weak.
Bank of England policymaker David Miles, who has recently voted to extend quantitative easing, said on Thursday there was a good case for restarting monetary stimulus. He said the central bank may need to buy up to 175 billion pounds more of government bonds if growth is far below potential.
Traders said the central bank's policy of tolerating some inflation to support growth and the risk of a downgrade to the UK's triple-A sovereign rating left longer-term investors increasingly inclined to sell the pound. Many expect the pound will soon drop to $1.50.
"When the UK has a central bank that has turned its back on an inflation target and at the same time there is the potential for it to do more quantitative easing, long-term investors are questioning whether this is a good place to hold their money," said Simon Smith, economist at FXPro.
"In the very short term, sterling could see a bit of a correction but thereafter it will push towards $1.50 and could be around the $1.45 area by mid-year."