* Sterling close to 4-month high versus euro EURGBP=D4
* Sovereign funding risk plagues euro, more downside seen
* Rising rate expectations supporting sterling
By Neal Armstrong
LONDON, Jan 11 (Reuters) - Sterling hovered close to a four-month high versus a struggling euro on Tuesday as sovereign funding worries plagued the single currency and the increasing prospect of higher interest rates in the UK supported the pound.
The euro remained on the back foot with the focus on whether Portugal will be able to raise funds in the debt market on Wednesday or be forced to turn to the European Union and IMF for financial aid. Bond auctions in Spain and Italy will also be closely scrutinised this week.
Sterling traded around 83.01 pence per euro EURGBP=D4 in afternoon dealing after holding within a tight range throughout the day, but it was not far off a four-month high of 82.85 hit on Monday when the euro came under broad selling pressure.
"It's primarily euro weakness that's been driving EUR/GBP but there's also some emphasis shifting to whether the UK will have to raise rates soon," said Gavin Friend, currency analyst at nabCapital.
"But any hike that comes this year to re-establish the Bank of England's credibility on inflation shouldn't be a long-term positive for sterling," he added.
Industry groups fear that louder mutterings about the BoE's credibility could drive it to tighten policy before a fragile economic recovery warrants it, particularly with harsh government spending cuts about to bite.
"Public policy tensions over rising inflation pressures and a necessary BoE policy response are lifting sterling. We see further sterling upside as this driver gains greater traction this week." said Credit Agricole CIB analysts in a note to clients.
The BoE is expected to keep rates unchanged at this week's policy meeting, but Citi recently changed its call to expect two rate rises this year, with Societe General bringing their expectation for a first rate hike forward to August.
Technicals were showing further room on the downside for the euro, with Commerzbank analysts highlighting potential for a move to the June 2010 low at 80.67 against the pound.
Sterling sat tight against the dollar to $1.5555 GBP=D4, towards the top end of a $1.5345/1.5680 range set from the end of December.
Traders said demand from Asian and Latin-American sovereign accounts helped to underpin the pound on the day, together with leveraged buying. Stop-loss orders were reportedly lurking at $1.5610.
