Brutal sell-off in sterling takes a breather as markets stabilise

LONDON (Reuters) - Sterling rallied on Friday as investors regained some risk appetite in a market calmed by a halt in the oil slide and a signal that the European Central Bank will ease policy further in March.

Mixed data showing UK government borrowing dropped sharply in December while retail spending suffered its biggest year-on-year fall in over six years, sent sterling briefly down. But it climbed back above $1.43 to trade at $1.4346, up 1 percent on the day. The currency had hit a seven-year low of $1.4080 earlier this week.

The euro was down 1.6 percent against the pound at 75.33, retreating from a one-year high of 77.56 struck on Wednesday. The euro has been losing ground since Thursday afternoon on a hint from ECB chief Mario Draghi that it will add more stimulus to an already expansive easing programme at its next meeting in March.

Bank of Tokyo-Mitsubishi UFJ currency economist Lee Hardman said that after a highly volatile start to the year, Draghi had managed to calm markets. That was now helping sterling, he said, which has tended recently to perform badly at times of risk aversion as investors turn to the yen and euro.

"The pound is rebounding after being beaten so badly in the first couple of weeks of this year," he said. "The retail sales data doesn't change a great deal. The big picture is still that personal consumption in the UK is still the strongest part of the economy."

Sterling has lost nearly 4.5 percent on a trade-weighted basis in the past five weeks as investors have pushed back bets on when British interest rates will start to rise and on intensifying concerns over a possible "Brexit" -- exit from the Europe Union.

In the past few weeks, a wave of bets in the derivatives markets have been placed by investors seeking protection against risks from a referendum on Britain's EU membership, now widely expected by markets to take place later this year.

"We would expect more speculators to play catch up and keep sterling under pressure," said Chris Turner, head of currency strategy at ING.

"And there is another community that will also look to sell -- the corporate sector. They have been watching with horror the slide in sterling. We could see them increase their hedging ratios, given all the risks from Brexit."

(Additional reporting by Anirban Nag; Editing by Catherine Evans)

By Jemima Kelly