* Sterling hits 7 1/2-year low vs dollar on UK banking woes
* Euro/dollar hits 6-week low
* Stocks slide keeps risk aversion high, boosting dollar
(Changes dateline, byline, releads, adds comment, updates prices; previous TOKYO)
By Naomi Tajitsu
LONDON, Jan 21 (Reuters) - Sterling tumbled on Wednesday, hitting a 7 1/2-year low against the dollar, as intensified risk aversion drove investors back into the U.S. currency which reached its strongest levels against the euro in six weeks.
Economic worries around the world stung global stock markets and sliding European shares kept demand high to dump risky assets. The pound extended deep losses on the view that an ailing UK banking sector will keep the economy weak despite drastic interest rate cuts.
Sterling suffered after Bank of England Governor Mervyn King on Tuesday said that the UK economy will likely shrink significantly in the first half of the year, and that policymakers need to consider using more than just interest rates to stimulate demand
Economic worries were not confined to the UK, however. European shares fell 2 percent and edged towards its lowest in nearly six years, reminding investors that the global economy is continuing to suffer despite dramatic rate cuts and fiscal stimulus plans by authorities around the world.
"It's still a positive environment for the dollar, with equities down. The dollar and the yen are still strong in this risk-averse environment," said Marcus Hettinger, global currency strategist at Credit Suisse in Zurich.
"With other central banks cutting rates down to the level of the U.S. and Japanese central banks, there's still more downside for currencies like sterling and the euro.
Sterling fell more than 1 percent to $1.3715, its weakest level since mid-2001. The pair has fallen more than 7 percent so far this week, its biggest weekly slide since late October.
The UK currency has been pummelled this week, after the Royal Bank of Scotland announced massive losses on Monday. This has reinforced investor worries about the UK's hobbling financial sector even after a second government bank rescue plan launched earlier in the week.
Sterling dropped across the board, hitting a record low of 123.20 yen against the low-yielding Japanese yen, which tends to rally during periods of risk aversion.
"Concerns over the budget outlook as the UK and other governments attempt to spend their way out of recession will keep the pressure on gilts and keep sterling firmly on the back foot," analysts at Calyon wrote in a research note.
The euro rose 1.3 percent to 93.97 pence, its strongest since the start of the month though off a record high around 98 pence hit last month.
Despite the euro's gains against sterling, the common currency fell to $1.2845 on electronic trading platform EBS, its lowest level since Dec. 9.
This boosted the dollar across the board, pushing the U.S. currency as high as 86.504 against a basket of currencies, its highest level since early December.
Against the yen, the dollar was little changed at 89.67 yen.
The euro has been hurt lately by sovereign debt rating downgrades to euro zone member nations including Spain, and deteriorating economic prospects, which analysts say could hasten monetary easing by the European Central Bank.
A European Commission report on Monday forecast the euro zone economy would shrink 1.9 percent in 2009.
Market players awaited remarks by European Central Bank President Jean-Claude Trichet later on Wednesday for hints about monetary policy steps at the ECB's next meeting in February.
Traders said other factors that could have an impact on currencies include U.K. labour market data and the Bank of England's minutes of its January 7-9 monetary policy committee meeting. Both are due later on Wednesday.
(Editing by Ruth Pitchford)