* Reduced safe-haven move supports stronger greenback
* Dollar index set for biggest weekly fall since early May
* Sterling dips from recent peaks tied to economic strength
* U.S./U.K. two-year yield spread widest since August 2011 (Updates market action, adds quote)
By Richard Leong
NEW YORK, June 20 The dollar stayed firm on Friday as U.S. bond yields held steady, while sterling slipped from its recent peaks tied to expectations the Bank of England might raise interest rates by early 2015 on signs of a strengthening British economy.
Reduced jitters about the fighting in Iraq also supported the dollar as traders trimmed their safe-haven holdings in gold, U.S. Treasuries and Japanese yen.
"The dollar has drifted in a pretty small range," said Omer Esiner, chief market strategist at Commonwealth Foreign Exchange Inc. in Washington.
The dollar index clung to a slim 0.07 percent gain at 80.39, shaving its weekly loss to 0.2 percent, still on track for its biggest one-week drop since the week ended May 2.
The benchmark 10-year Treasuries yield rose to 2.66 percent before easing to 2.63 percent in late U.S. trading, little changed on the day. The 10-year yield has bounced in a 10 basis point range established two weeks ago.
Analysts said the greenback's move was limited by light trading volume and the absence of fresh U.S. economic data.
"Until we get a surprise on the geopolitical front, most major currencies will be tracking bond yields in the near term," Esiner said.
The dollar index was poised for its worst week since early May after the Federal Reserve downgraded its long-term U.S. growth outlook and markets perceived comments by Fed Chair Janet Yellen as dovish.
The U.S. currency was last up 0.2 percent against the yen at 102.13 yen, while the euro dipped 0.1 percent to $1.3593 .
The gap between U.S. and German 10-year yields narrowed to 1.276 percentage points from 1.296 on Thursday, which was its widest since mid-1999, shortly after the euro debuted.
STERLING HOLDS SHINE
Sterling hovered within striking distance of Thursday's 5-1/2-year high of $1.7064 after data showed U.K. factory orders grew at their fastest pace in six months in June. The report highlighted the probability that the BoE may raise rates well before the Fed.
"Sterling is a favorite right now, and the BoE seems to be the only major central bank that is likely to deliver on higher rates," said Niels Christensen, an FX strategist at Nordea in London.
Analysts projected the BoE will likely raise policy rates in the first quarter of 2015 while the Fed will follow suit in the second half of next year.
This view raised the yield premium on two-year British Gilts over two-year U.S. Treasuries to 0.44 percent, a level not seen since August 2011.
The pound dipped 0.2 percent versus the dollar to $1.7008 and also eased versus the euro, which was trading at 79.92 pence. (Additional reporting by Anirban Nag in London and; Shinichi Saoshiro in Tokyo; Editing by Andrea Ricci)