Sterling hits 3-mth high vs dlr on rate hike prospects

* Sterling hits 3-month high of $1.6232 on higher rate view

* Hawkish BoE comments, above-forecast construction PMI help

* Next target for sterling/dollar is Nov 2010 high of $1.63

By Jessica Mortimer

LONDON, Feb 2 (Reuters) - Sterling rose to its highest in three months against the dollar and gained versus the euro on Wednesday as upbeat data and hawkish central bank comments supported expectations for higher UK interest rates.

Data showed British construction activity returned to growth in January, with the PMI index on the sector rising to 53.7 and easily beating forecasts for 49.9 [ID:nLAK002737], seen as a further sign the economy has started to rebound in 2011.

Earlier, Bank of England hawk Andrew Sentance warned against delaying rate rises to tackle inflation [ID:nL3E7D20HH] while Deputy Governor Charles Bean was quoted saying the bank may be forced to hike if commodity prices rise further. [ID:nLDE7110IV]

"The case for a rate hike is becoming more compelling and sterling is benefiting on the back of that," said Audrey Childe-Freeman, EMEA head of currency strategy at JP Morgan Private Bank.

Implied interest rate futures based on overnight index swaps were almost fully priced for a 25 basis point rate rise in May, up from around 40 percent last week after a shock 0.5 percent contraction in UK fourth quarter gross domestic product. BOEWATCH

Markets are also pricing in an 18 percent chance that the BoE will hike rates as early as next week.

Sterling was up 0.2 percent against the dollar GBP=D4 at $1.6175, having hit a three-month high of $1.6232. It came off its highs as the dollar gained ground against the euro, though it continued to outperform most major currencies.

Further gains could see it test its early November high around $1.6300, above which would mark a 12-month high.

The euro fell 0.45 percent to 85.30 pence EURGBP=D4, though it stayed above Tuesday's low of 85.10 pence, with the single currency also supported by talk of interest rates in the euro zone rising sooner rather than later.

"The fact that construction PMI bounced back far more aggressively than anticipated plays into the hands of the rate hike story," said Jeremy Stretch, currency strategist at CIBC.

The construction PMI followed manufacturing PMI data on Tuesday that was way above forecasts, offering further signs that the economy was rebounding in 2011 after a surprise 0.5 percent contraction in fourth quarter gross domestic product.

With growing rate hike expectations increasingly priced in, however, some feel sterling may struggle to extend its gains.

"It seems to us that some of the pound's positives have been priced into the FX markets by now, so further upside especially in cable from current levels maybe less pronounced in the near term," said Valentin Marinov, currency strategist at Citi. (Reporting by Jessica Mortimer and Anirban Nag; Editing by Catherine Evans)