LONDON (Reuters) - Sterling rose against the dollar on Friday, shaking off an earlier slide as traders dumped the U.S. currency after a UK ratings outlook downgrade the previous day fuelled speculation that the United States' triple A rating may be at risk.
Broad dollar weakness helped the pound to close in on a 6 1/2-month high hit earlier on Friday, but the UK currency fell versus a stronger euro, which hit a 4 1/2-month high against the dollar.
The UK currency has largely recovered after tumbling on Thursday, when S&P surprised markets by cutting its outlook on the UK to "negative" from "stable," and saying that government debt could near 100 percent of gross domestic product.
"There's a realisation that a lot of governments -- and there's a lot of attention on the U.S. today -- are facing far weaker fiscal positions than the UK," said Chris Gothard, currency strategist at Brown Brothers Harriman in London.
"So people are realising that just selling sterling yesterday was not the appropriate route, while the wider theme is of dollar weakness."
The pound had clawed back initial losses suffered after the announcement, and some analysts pointed out that a cut to Britain's triple A rating remained a long way off, particularly as the economy takes small steps towards economic stability.
By 12:35 p.m., sterling traded 0.2 percent higher at $1.5870, recovering from the day's low of $1.5757 to trade close to $1.5898 in earlier trade, its highest since early November.
The pound has rallied roughly more than 4.5 percent so far this week, putting it on track for its best weekly performance since early February.
Some in the market say that the UK currency is heading for additional gains against the dollar, with many traders saying that a climb above $1.60 is a big possibility given that the pair broke above its 200-day moving average earlier this week.
The pound showed little initial reaction to figures showing that the UK economy contracted 1.9 percent on the quarter and 4.1 percent on the year in January-March, unchanged from a first reading.
Also boosting the pound and also other currencies including the euro was a 0.3 percent climb in European shares <.FTEU3>, while UK stocks <.FTSE> rose nearly 0.7 percent.
But even as sterling climbed against the dollar, it fell versus the euro, which edged up 0.3 percent to 87.80 pence.
The euro's climb against sterling has been driven by its 3.5 percent rally against the dollar so far this week, as a darkening view of the U.S. economy and its financial woes has put the U.S. currency under broad selling pressure.
Some analysts said that data showing a bigger-than-expected rise in retail sales on Thursday and strong demand at an auction of gilts after S&P's move were also positive factors for sterling.
Bank of England Deputy Governor Charles Bean said on Thursday that the low-point in UK economic activity was not far off, but added that the strength of any recovery was uncertain and likely to be relatively low.
He also said that the central bank faces a tricky call in deciding how to tighten monetary policy as the economy recovers, and would not rush into hefty gilt sales.
(Reporting by Naomi Tajitsu; editing by Stephen Nisbet/Victoria Main)