May 28, 2014 / 2:46 PM / in 3 years

Sterling hits 6-week low vs dollar, biggest fall in 4 months

LONDON, May 28 (Reuters) - Sterling slid to a six-week low against the dollar on Wednesday, pressured by a broad rally in the U.S. currency and signs that the red-hot British housing market may be starting to cool.

After figures this week showed UK mortgage approvals in April fell to their lowest since August last year, the head of Britain's No.3 mortgage lender Nationwide told Reuters the market could be in the early stages of a "natural correction."

That prompted traders to pare back some of the more aggressive bets that the Bank of England could begin raising interest rates later this year.

The gap between two-year UK yields and U.S. yields, which still makes holding the pound a more lucrative investment than buying dollars, narrowed to its smallest in two weeks.

A combination of month-end dollar buying from a broad range of market participants and over-extended bets on sterling appreciation also encouraged traders to cash in on the pound's recent climb to multi-year highs.

"The market is very long of sterling and we are rather at extreme levels in terms of positioning and price," said Stephen Gallo, currency strategist at BMO Capital Markets, also pointing to a "little bit of unease" over the housing market.

Sterling fell as low as $1.6709. That marked a loss of 0.6 percent on the day, the pound's biggest one-day fall against the dollar in almost four months.

A close on Wednesday below $1.6737 "would add to downside risks", opening up a move lower to $1.6687 then $1.6558, said George Davis, chief technical analyst at RBC Capital Markets in a note to clients.

The pound fell to a one-week low against the euro, with the euro up a third of a percent on the day at 81.35 pence .

Sterling was among the major decliners on Wednesday against the rampant dollar - which rose to a near two-month high on a trade-weighted basis - because bullish bets had been built up to more extreme levels.

Financial markets still widely expect the BoE to be the first major central bank to raise interest rates following the emergency post-crisis rate cuts to virtually zero. But it may not be this year, as some traders had started to speculate.

The consensus in a Reuters poll of economists on Wednesday showed the first rate hike is likely to be some time in the second quarter of next year, although at least one rate-setter will break ranks and vote for a move by August. {ID:nL6N0OD4C2]

"The clear outperformer and everyone's favourite in the first half of the year has been sterling. But people are getting a little bit nervous about these long positions given that the BoE seems to be right on (moderate-to-low) inflation ... and that means a softer outlook for rate hikes," said Marvin Barth, a currency strategist at Barclays in London.

British yields were down across maturities with the 10-year yield down 7 basis points at 2.574 percent - its lowest in over a week - as German yields also fell on more dovish talk from European Central Bank officials.

An ECB meeting next week could yield a combination of policies to tackle low inflation and low credit growth, but the timing of the implementation could vary, ECB Executive Board member Yves Mersch said on Wednesday.

The two-year gilt yield was 28 basis points higher than the comparable U.S. yield, down 10 basis points since the start of this week and the smallest premium in two weeks. (Reporting by Jamie McGeever and Ana Nicolaci da Costa; Editing by Catherine Evans)

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