* Euro/sterling drops to fresh 3-1/2 year low
* Pound falls vs dollar after Bernanke comments
* Weaker UK inflation gives room for loose BoE policy
By Jessica Mortimer
LONDON, July 17 Sterling rose to a 3-1/2 year high against a broadly weaker euro on Tuesday but fell against the dollar after U.S. Federal Reserve Chairman Ben Bernanke gave no firm hints the central bank would opt for another bout of quantitative easing.
Bernanke told lawmakers the Fed bank stood ready to offer additional monetary policy support but gave few details, boosting the dollar as many in the market had anticipated he would signal more stimulus in the coming months.
The pound fell 0.4 percent against the dollar to $1.5578, well off a high of $1.5677 hit earlier as the U.S. currency came under pressure before the Fed chief's testimony.
But it reversed earlier losses against the euro, which dropped to 78.315 pence, its weakest since late 2008. It stopped short of a reported options barrier at 78.25 pence, traders said.
Earlier, sterling had fallen after weaker-than-expected UK inflation data suggested the Bank of England had leeway to keep monetary policy loose for some time, but the impact was limited.
The BoE announced a further programme of quantitative easing via asset purchases earlier this month and policymakers will be waiting to see how this feeds through into the economy.
"We saw an initial sterling sell-off but attention has turned back to the dollar," said Jennifer Hau, currency strategist at Lloyds.
"A weaker inflation number has prompted the argument that it removes the obstacle to further stimulus. But it's hard to expect that to have an underlying impact on sterling given they have just announced more QE that is due to expire in November,"
The pound was expected to remain buoyant against the euro as the euro zone debt crisis encourages investors to switch out of the currency into perceived safer alternatives.
The euro was hurt by comments from Italian Prime Minister Mario Monti, who said he expected the governor of Sicily to resign given a growing financial crisis that has pushed the autonomous region close to default.
Sterling has made steady gains versus the euro since the European Central Bank cut interest rates earlier this month.
Data showed UK consumer price inflation fell to 2.4 percent in June, its lowest since November 2009, and undershooting forecasts for a reading of 2.8 percent.
Many analysts said falling prices justified the BoE's asset purchases, intended to stimulate lacklustre economic growth, and said the 375 billion pounds programme could be expanded.
"It seems like this will give the BoE room to manoeuvre. They know they can now buy even more because inflation is finally coming down," said John Hydeskov, chief analyst at Danske Markets.
Quantitative easing can be considered currency negative because the bond-buying programme involves pumping more pounds into the system, potentially weighing on demand.
But some analysts said the data should be seen as positive for the pound in the longer term as it could enable consumers to spend more and help lift the UK economy out of recession.
"It will feed down into disposable incomes in households which have been decreasing for the last few years, so eventually it will be a good thing for sterling, but not intra-day today," said Danske Bank's Hydeskov.
Trending On Reuters
- Lackluster U.S., China sales drag on Ford Motor profit, shares tumble
- Fall in Volkswagen brand profit shows lasting effects of scandal
- Shell misses expectations as earnings plunge on oil, BG costs
- SoftBank sees sharp recovery for Sprint, flags much investment for ARM
- Facebook shares hit record high as it beats estimates again