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* Pound pulls back from Tuesday's two-year high vs dollar
* Underperforms euro for second day
* Drop leads to more British exporters hedging exposure
LONDON, Dec 11 (Reuters) - Sterling fell to a three-week low against the euro on Wednesday on steady selling by hedge funds trimming favourable bets while waiting for more evidence of a durable recovery in the British economy.
The pound also pulled back from a two-year high against the dollar reached on Tuesday after upbeat comments from Bank of England chief Mark Carney and strong house prices. The currency took its cue from British gilt yields that fell on Wednesday, erasing some of the rate differentials in favour of the pound.
The pound was down 0.25 percent at $1.6405, off Tuesday's $1.6468. Despite the latest losses, the pound is still up for the month and nearly 5 percent higher in the past six months.
It underperformed the euro which extended gains into a second straight day. The euro rose 0.5 percent against the pound to 84.14 pence, its highest since Nov. 20, boosted by tight liquidity conditions in the euro zone and European banks repatriating funds to shore up their capital bases for an ECB asset quality review.
"Profit-taking on the pound's recent gains ahead of the holiday break appears to be the driver behind the UK currency's fall, and comes despite a highly uncertain outlook for the euro moving into 2014," said Mark Bolsom, head of corporate banking at Western Union Business Solution.
"We are receiving a high number of calls after the pound fell to a three-week low against the euro, giving British exporters an opportunity to consider hedging at least part of their 2014 euro exposure."
The European Central Bank's reluctance to ease policy to beat disinflation has also helped the euro.
"In the near term, the momentum does look a bit weak for sterling and in favour of the euro given the less dovish stance of the ECB," Yujiro Gato, currency strategist at Nomura, said.
"But in the medium term we are bullish on sterling over the euro given the different economic outlooks for the euro zone and the UK. To us, sterling will still be the best-performing European currency."
Data out of British has showed slightly stronger than forecast industrial output data, while the National Institute of Economic and Social Research said on Tuesday that growth was picking up. The economy grew an estimated 0.8 percent in the three months to the end of November, up from 0.7 percent in the three months to October.
Bank of England Monetary Policy Committee member Martin Weale said on Wednesday he was concerned about a pick up in inflation expectations since August but blamed higher energy prices for that.