* BoE easing speculation keeps pressure on pound
* But UK easing concerns overshadowed by dollar weakness
* Technicals favour euro over pound, next target 90 pence
* Volatility rising; Oct spending review in focus
By Tamawa Desai
LONDON, Oct 18 (Reuters) - Sterling is seen holding ground against an ailing dollar in coming months but may lag the euro and other currencies on persistent speculation the Bank of England will ease policy further to aid a faltering economy.
Expectations for more stimulus grew after the U.S. Federal Reserve indicated it was ready for more quantitative easing and Monetary Policy Committee member Adam Posen suggested he would vote for an expansion of the BoE's asset-buying programme.
UK finance minister George Osborne has also said he will sanction more QE if the central bank sees it as necessary.
For the pound, the way forward seems twofold.
Expectations the Fed will loosen monetary policy next month mean it is expected to hold recent gains against the dollar, but the UK currency may struggle against the euro after the European Central Bank signalled an end to its special liquidity measures.
Having breached a key level of $1.60, analysts expect sterling to hold near that level over the next three months, but slip to as little as 90 pence against the euro.
"We have been bullish on the pound for three reasons: the more proactive fiscal stance of the government, relative monetary policy and valuation on a purchasing power parity basis, as the pound is now the most undervalued currency in the G10," said Barclays Capital currency strategist Raghav Subbarao.
Purchasing power parity refers to a theory that estimates the amount of adjustment needed in an exchange rate in order for purchasing power to be equivalent in each currency.
Barclays forecasts the pound to trade around $1.61 by year-end. It hit a 8-month high of $1.6108 on Friday.
Data from the Commodity Futures Trading Commission shows currency speculators have reversed bets against sterling and were positioned for the currency's advance. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Graphic on sterling positioning http://graphics.thomsonreuters.com/10/GLB_IMMGBP0510.jpg ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
In the options market, one-month risk-reversals for sterling/dollar have come back to be fairly neutral at around 0.40 from 0.90 before the September Fed meeting, indicating market players have scaled back near-term bets on the pound falling.
VOLATILITY
Near-term implied volatility is seen stabilising, reducing the risk of further downside, analysts say. However, three-month sterling/dollar implied volatility suggests traders may be bracing for some weakness going into year-end.
On Monday, three-month vols were seen around 11.35 compared with one-month vols around 11.00.
Market players will be watching the government's spending review on Oct. 20, which will detail plans to cut a record budget deficit to almost nil in five years, while the BoE will unveil its latest quarterly projections for the economy and prices in November. Monetary policy is expected to remain loose.
"Sterling has been a strong laggard in the G10," said Pierre Lequeux, head of currency management at Aviva Investors in London. "The direction will be driven more by QE than anything else but it is not clear what that will be."
Meanwhile, the euro is expected to keep the upper hand over the pound, given the ECB's more hawkish monetary policy outlook.
"The euro/sterling pair continues to rise, with a next target of 88.65 pence and then to the 90 area," said Ian Stannard, senior currency strategist at BNP Paribas.
But others say euro gains may be limited to around 86 pence over the next three months as the pound proves resilient against the dollar.
Analysts said Britain has little incentive to join in the 'currency war', as some have labelled attempts by some countries to weaken their currencies, as trade-weighted sterling is moving lower. The index fell some 2 percent against a basket of currencies in the third quarter. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
TWI FX moves since 2007 http://r.reuters.com/qun86p ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
The domestic economic picture remains mixed, with higher inflation and improvement in jobs countered by a weakening housing market and lower consumer confidence. The economy faces potential headwinds from a rise in the value-added tax early next year and the fiscal spending cuts.
Monetary policy remains loose but most analysts say the central bank will not be in a rush to take further easing steps, especially as inflation remains above its 2 percent target and as one policymaker has continued to vote for higher rates.
"Whereas the Bank of Japan has moved to loosen and the Fed will probably add more stimulus, we believe the MPC will not expand QE further unless the UK economy weakens significantly," said Michael Saunders, economist at Citi.
"The hurdle for further action is much higher." (Graphics by Scott Barber; Editing by Catherine Evans)