* Euro backs off 2-mth high vs dollar, more losses for now
* Sterling tumbles after UK Q4 GDP shrinks unexpectedly
(Updates prices, adds quote, detail)
NEW YORK, Jan 25 (Reuters) - The euro came off a two-month high on Tuesday with more losses seen near term after an oversubscribed euro zone rescue fund's first offer of debt, while the pound dived after a shock contraction in the UK economy last quarter.
Dollar buying against the pound on stop loss orders had already pressured the euro but 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 those gains were quickly eroded when investors who had built up euros to buy EFSF debt sold them back.
"Euro/dollar traded at $1.3680 early in the London morning before reversing sharply down to $1.3580 on a stop driven dollar buy frenzy following the UK GDP numbers," said Brad Bechtel, managing director at Faros Trading LLC in Stamford, Connecticut. "The oversubscribed EFSF was also blamed as bids not filled had to sell accumulated euro."
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.
Expectations the European Central Bank would lift interest rates before the U.S. Federal Reserve underpinned the single currency this month, more so after talk on inflation and interest rates by ECB chief Jean-Claude Trichet on the weekend.
In early New York trade, the euro was trading 0.3 percent
lower at $1.3594
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.
DOWN POUND
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 some 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 in London.
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
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 was down 0.1 percent at 82.37 yen