* Strong UK services sector data lifts pound
* Gains seen limited before central bank Inflation Report
* Indication of prolonged easy policy could weigh on sterling
By Anooja Debnath
LONDON, Aug 5 (Reuters) - Sterling rose on Monday after Britain's services sector expanded at its fastest pace in over six years in July, adding to evidence the UK economy is recovering.
But the pound's gains are likely to be limited before Wednesday's Bank of England Inflation Report, in which the central bank could provide forward guidance and indicate that interest rates will stay at record lows for a prolonged period.
Sterling was up 0.2 percent at $1.5325, having hit a session high of $1.5380. The euro was down 0.5 percent at 86.465 pence.
"If (the Bank of England) is fairly explicit that its policy will be expansive for a considerable period and ties it to some economic variables ... then we would easily look for a break down through to $1.5250 in sterling and perhaps to as low as $1.5150," said Jeremy Stretch head of currency strategy at CIBC.
Short-term interest rates are being anchored by expectations that the central bank may commit to keep its key policy rate low at least until late 2015/2016. Money market rates like overnight indexed swaps are pricing in the possibility of the first move in the bank rate, currently at 0.5 percent, in three years.
A 25 basis point rate hike is being fully factored in in four years' time.
Sterling was boosted earlier on Monday after data showed the services sector purchasing managers' index (PMI) jumped to 60.2 in July from 56.9 in June, its highest since December 2006 and beating the top forecast in a Reuters' poll.
The pound pared some of those gains against the dollar which rose after a report showed that the U.S. services sector had accelerated faster than expected in July.
The growth surge in Britain's dominant services sector came after last week's strong rise in construction activity. All that added to the view the British economy had made a strong start to the third quarter after expanding in the second quarter.
"Sterling cannot ignore that these numbers are very impressive," said Craig Erlam, analyst at Alpari, adding that the currency could, however, struggle to stay above $1.5350 before the Bank of England's Inflation Report.
But with the recent spate of positive economic data, some analysts said there was an outside chance the central bank could sound less dovish than expected and this could see sterling rebound in the near term.