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* Sterling slips to lowest since June 2010 vs dollar
* Trade-weighted index falls to 20-month low
* UK manufacturing output falls sharply in January
* UK recession fears, increased QE bets weigh on currency
By Philip Baillie
LONDON, March 12 (Reuters) - Sterling struggled near a 2-1/2 year low against the dollar on Tuesday after weak data tipped the British economy ever closer to recession and increased bets on more bond purchases by the Bank of England.
Sterling was down 0.3 percent on the day at $1.4874. It had fallen to $1.4832, its lowest since June 2010 after UK manufacturing output slumped in January at its fastest pace since last June.
The euro was 0.1 percent up at 87.60 pence, not far from a more than two-week high of 87.84 pence, hit after the data. Strategists said from here the next target for the euro could be 88.15 pence, the more than 16-month high hit on Feb. 25.
Losses against the euro and the dollar pushed sterling's trade-weighted index to a 20-month low of 77.7, BoE data showed.
"At the moment...all roads seem lead to a weaker (sterling) exchange rate (as a way) to help economic growth accelerate and to lead to a rebalancing of the economy," said Paul Robson, currency strategist at RBS.
"We think there will be a dollar kicker for sterling... Increasingly the dollar is on a better footing given its relative growth performance."
RBS' Robson said sterling/dollar would target $1.42 over the next couple of months, adding that risks to sterling would be more acute before the UK budget and also before investors could make a reassessment of the impact a weaker pound on the economy.
The National Institute of Economic and Social Research said British economic output had contracted between December and February, another indication the economy would struggle to avoid recession.
Rising speculation the BoE would be compelled to print more money via gilts purchases to support the faltering economy stood in contrast to the United States, where a string of better data has supported the view the Federal Reserve may scale back its asset purchase programme later this year.
Analysts also said investors would prefer expressing a bearish view on the British economy by selling sterling against the dollar rather than the euro given that the U.S. economic outlook has been more upbeat than that of the euro zone.
The pound has been one of the worst-performing major currencies in 2013, falling 8.5 percent against the dollar and around 7 percent against the euro.
Demand for options betting on sterling weakness persists. One-month risk reversals showed the premium demanded to buy bets on sterling falls hovered near its highest since July 2012.
Strategists also said minutes from the central bank's Monetary Policy Committee on the likelihood of further quantitative easing (QE), the UK budget on March 20 and data releases were likely to see sterling suffer further losses.
"If economic data continues to remain weak, like we saw today ... it could make it easier for the BoE to loosen policy," said Raghav Subbarao, chief FX options strategist at Barclays Capital. "Although our base case is for no more QE from the BoE just yet, it is a very finely balanced call."
Markets will remain wary of sterling ahead of the UK budget next week. Speculation is mounting that Chancellor George Osborne may announce a review of the Bank of England's remit and give it more leeway on inflation targeting.