(Corrects paragraph 15 to .. 1.2770 francs .., not .. 1.2670)
* Euro backs off 2-mth high vs dollar, support at $1.3585
* Stop-loss hunting in euro/dlr after EFSF, Spain auctions
* Sterling tumbles after UK Q4 GDP shrinks unexpectedly
By Tamawa Desai
LONDON, Jan 25 (Reuters) - The euro came off a two-month high on Tuesday as the euro zone rescue fund's first offer of debt attracted strong demand as expected, while the pound dived after a shock contraction in the UK economy last quarter.
Speculation about potential interest rate increases in the euro zone and Britain eased as the poor UK GDP data switched investors' focus to worries about growth rather than inflation.
The order book for the European Financial Stability Facility's (EFSF) inaugural debt issue closed with bids valued at 43 billion euros for the 5 billion euros of paper on offer, a source at the EFSF said. [ID:nBRU011276]
Speculation the new issue would be massively oversubscribed boosted the euro in early trade, but it was unable to extend gains on the results as they did little to increase optimism for a comprehensive solution to euro zone debt problems.
"Some positives had been priced in yesterday on news about the size of the order books going into the issuance (so) today's news adding to that was not a massive positive for the euro," said Valentin Marinov, currency strategist at Citi.
Expectations the European Central Bank would lift interest rates before the U.S. Federal Reserve have underpinned the single currency this month due to tough talk on inflation and interest rates by ECB chief Jean-Claude Trichet.
By 1149 GMT, the euro was trading 0.1 percent lower at
$1.3635
Initial support was seen around $1.3585, a key trendline off the January lows, traders said.
Traders said the euro would need to hold above $1.3570 -- a 50 percent retracement of its decline from November to early this month -- on a sustained basis to extend its gains.
Sterling tumbled after a surprise 0.5 percent contraction in fourth quarter UK GDP due to adverse weather, compared with economists' forecasts of a 0.5 percent gain [ID:nAHLOCE7CK].
The pound fell as much as 1.4 percent against the dollar to
a session low
"The UK GDP may be a warning sign of what is to come in Europe. Market participants may reassess the rate hike scenarios which had led to a short squeeze," said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ.
Some economists said the surprisingly poor reading suggested the Bank of England would be much more cautious about the threat of lasting inflation, which would weigh down the UK currency.
Others argued the impact of persistent price pressures on a weak economy would heighten the risk of stagflation, which would also be negative for sterling.
The Swiss franc rallied broadly, rising sharply against the
euro
DEBT AUCTIONS
Markets offered limited reaction to strong results at an auction of Treasury bills in Spain, which added to signs that perceptions of weaker euro zone economies are improving. [ID:nLDE70O0JW]
Analysts said Tuesday's successful issuances were not enough to instil more optimism into the euro. "Ultimately the auctions did not significantly change the picture for the euro," one London-based trader said.
The dollar index <.DXY> rose 0.1 percent to 78.14, coming off a 2-1/2 month low of 77.814 hit on Monday.
The dollar was down slightly at 82.35 yen
The Australian dollar