Sterling hits two-month low against rallying dollar

By Jemima Kelly LONDON (Reuters) - Sterling hit a two-month low against a dollar that soared to its highest levels in 14 years against a basket of currencies on Tuesday, the first day of London trading in 2017. The pound had earlier hit a two-week high against the euro after a survey suggested British manufacturing growth had climbed to a two-and-a-half-year high last month. The monthly purchasing managers' index (PMI) for the manufacturing sector rose to 56.1, the strongest reading since June 2014. That exceeded all forecasts in a Reuters poll, which pointed to a decline to 53.1, adding to signs that the economy ended 2016 strongly. But as the dollar surged after the equivalent U.S. manufacturing PMI hit a two-year high, sterling weakened against the greenback, falling to $1.2200 - its weakest since the end of October - before recovering to $1.2255, still down 0.2 percent on the day. Against the euro, though, sterling rose 0.2 percent to 84.98 pence, having earlier traded as strongly as 84.51 pence. "One has to distinguish between the broad dollar strength we are seeing right now and ... sterling weakness," said Societe Generale currency strategist Alvin Tan. "In the near term, euro/sterling is probably a better gauge for sterling direction, because the consensus is quite bullish dollar. But one has to be careful about euro/sterling as we get into the spring because I think European political risks will rise, and the euro could weaken for its own reasons." The pound tumbled 16 percent against the dollar and 14 percent against the euro in 2016, its worst annual performance in eight years, with the bulk of those falls coming after Britain voted on June 23 to leave the European Union. Uncertainty over how Britain leaves the bloc and worries over the likely economic impact are continuing to weigh on the currency and mean that even positive data surprises tend to have only a limited - and temporary - impact on the pound. "The main question for most economists is still the timing of the negative impact of the referendum outcome," said RBC Capital Markets currency strategist Adam Cole said. "It's going to be hard for sterling to make a lot of traction on the back of economic data which is still lagging events." PMI surveys for the construction industry and the UK's dominant services sector are due on Wednesday and Thursday. (Additional reporting by Alistair Smout; Editing by Kevin Liffey)