* Sterling hits 3-month high versus dollar, 7-week high vs yen
* But pound falls to 2-week low against buoyant euro
* Euro, risk appetite buoyed by talk of ECB action to stem crisis
* Weak UK public finances, manufacturing data weigh
By Jessica Mortimer
LONDON, August 21 (Reuters) - Sterling rose to a three-month high against the dollar on Tuesday but dropped against a buoyant euro due to growing expectations the European Central Bank will take action to ease Spanish and Italian borrowing costs.
The anticipation of measures being taken next month to tackle the euro zone's debt crisis emboldened investors, helping equity markets and currencies seen as higher risk, including sterling.
This lifted the pound to $1.5784, taking it above the mid-June peak of $1.5781. It also rose to a seven-week high against the safe-haven Japanese yen of 125.41 yen.
The UK currency underperformed the euro, however, with the market's focus on ECB action sparking a broad rise in the single currency. Weak UK public finances and manufacturing orders data also encouraged investors to sell sterling against the euro.
"This is really a euro move, with everything else being dragged around by that," said Steve Barrow, head of G10 currency research at Standard Bank.
"My view is that any rise in euro/sterling is there to be sold, but the market is waiting to see what comes out from the ECB and it would be foolish to stand in the way of that."
Talk of ECB intervention in debt markets resurfaced after a weekend report in Germany's Spiegel magazine that the central bank would target specific yield levels as part of any bond-buying programme.
The ECB played down that speculation on Monday but traders said the euro regained traction as Britain's Daily Telegraph said it could confirm the reports that ECB experts were examining plans to cap Spanish and Italian yields.
The euro rose 0.6 percent against the pound to 79.09 pence, its strongest since Aug. 8.
Sentiment towards sterling was also knocked by data showing Britain's public finances unexpectedly veered further off-track in July and a survey revealing a slump in factory orders this month as demand for consumer goods dropped.
But most analysts expect any gains in the euro to be capped, probably keeping it below the early August high of 79.63 pence due to uncertainties over the effectiveness of ECB bond-buying and worries about a weak euro zone economy.
They also said with the market's focus so firmly on developments in the euro zone, UK data would have limited impact on sterling, especially as most market players do not expect the Bank of England will ease monetary policy again before November.
"UK data at the moment matters to sterling at the margin, what matters more is what is going on in the euro area," said Sara Yates, currency strategist at Barclays.
She said any progress among policymakers on euro zone debt issues could prompt a short-term squeeze higher in sterling against the dollar, but forecast the pound to fall to $1.55 in one month's time given the BoE's current bias towards loose monetary policy.