* Pound falls vs dollar, tracking drop in euro
* UK manufacturing sector contracts for second month running
* BoE expected to opt for more QE later this week
* Optimism after EU summit deal wanes
By Michelle Chen
LONDON, July 2 (Reuters) - Sterling fell against the dollar on Monday as a survey showed UK manufacturing activity contracted for a second month running in June and tracking a drop in the euro as optimism following last week’s euro zone summit agreement waned.
The data backed the market’s view that the Bank of England is likely to opt for further quantitative easing at a policy meeting later this week in order to stimulate a sluggish economy.
The Markit/CIPS purchasing managers’ index for manufacturing rose to 48.6 last month in the UK from May’s three-year low of 45.9. The data was better than forecast but still left the index comfortably below the 50 mark dividing growth from contraction.
“Manufacturing activity is still contracting and the trend is still very weak ... Clearly it’s not going to change any plans the Bank of England might have in their own minds ahead of Thursday’s meeting,” said Neil Mellor, currency strategist at BNY Mellon.
Sterling was down 0.2 percent against the dollar at $1.5668, off a peak of $1.5718 hit on Friday when the market cheered moves to ease the euro zone debt crisis.
European leaders surprised markets last week by agreeing to let their rescue fund inject aid directly into stricken banks from next year and intervene on bond markets to support troubled member states.
Doubts lingered that it would solve the crisis, however. Finland said on Monday it would block the euro zone’s permanent bailout fund from buying government bonds in the open market, encouraging investors to take profit on last week’s gains in the euro and other riskier currencies.
The euro reversed earlier gains to trade down 0.1 percent against the pound at 80.52 pence. It stayed below chart resistance around 81.00 pence and the June 11 high of 81.63 pence.
Longer-term, the pound was expected to continue to gain against the euro as investors seek alternatives to the common currency.
The BoE is expected to top up the 325 billion pounds of cash it has already pumped into markets with another 50 billion when it meets on Thursday as falling inflation gives it more scope to support a battered economy.
“I think it would be very surprising if the Bank didn’t do additional asset purchase this week,” said Michael Derks, chief currency strategist at FXPro.
He said the pound could succumb to further profit-taking against the dollar in the short term, pushing it down towards $1.56.
Analysts expect a decision to expand QE would weigh on the pound although the impact could be limited because further monetary easing is already widely expected and because the market remains focused mainly on events in the euro zone.
“The talk of QE has been around for a week or so and sterling has not reacted that much. It’s all about the euro zone crisis, more than anything else,” BNY Mellon’s Mellor said.
He said the pound would see “a knee-jerk reaction lower” but said in the longer term if economic growth could be accelerated by the measures it would be positive to the currency.
He expected the euro to fall further towards 79 pence in the short term and that it could easily move down to the lower 70s if it broke 78 pence, but he saw the pound weakening against the safe-haven dollar. (Additional reporting by Jessica Mortimer; editing by Ron Askew)