* Euro surges, rallies to 2-1/2 month high vs dlr
* Euro hits record high vs sterling above 95 pence
* German Ifo index falls more than expected
* Markets keep eye on yen; await BOJ rate decision
(Adds quotes, updates prices)
By Tamawa Desai
LONDON, Dec 18 (Reuters) - The euro surged across the board on Thursday, buoyed by expectations that euro zone interest rates will not fall as steeply as those in other major economies despite data pointing to worsening German business sentiment.
The euro is set for its best weekly performance ever against the dollar, after the U.S. Federal Reserve cut benchmark interest rates to a historic low near zero on Tuesday.
In contrast, the European Central Bank seems more cautious about drastically reducing rates, where key rates now stand at 2.5 percent.
In thin volatile trade, the euro surged to a 2-1/2 month high against the dollar at $1.4719. By 1303 GMT, it was up 1.5 percent on the day at $1.4625.
The single currency also hit a fresh record-high above 95 pence and is also on track for its best week and month ever against the pound.
"The rise in euro/sterling is relentless, pushing the pair up toward parity," said Christian Lawrence, currency strategist at RBC Capital Markets in London.
The euro's rise accelerated despite a weaker-than-expected reading of the Ifo institute's index on German business sentiment. The headline index fell to 82.6 in December from 85.8 in November, below expectations of 84.0.
"The euro is picking up quite a lot of support -- the yield differentials have moved out and that may well be providing some support," said Ian Stannard, senior currency strategist at BNP Paribas.
Rate spreads support that view, moving sharply in the euro's favour.
Sterling was on the defensive as speculation that UK interest rates could fall sharply was fuelled by Bank of England Deputy Governor Charles Bean saying UK interest rates could fall to zero..
Minutes from the BoE's Dec. 3-4 rate-setting meeting showed policymakers had discussed cutting by a larger margin than the 100 basis point easing that took benchmark rates to 2 percent.
EYES ON MOF AND BOJ
The dollar also fell broadly, down one percent against a basket of currencies to 77.780, its weakest in more than two months and on track for its worst week and month ever.
But the greenback rose one percent against the yen to 88.25 yen as Japanese authorities stepped up their rhetoric against a stronger yen after dropping to its lowest in more than 13 years near 87.11 yen.
"You want to keep an eye on the yen with the ... finance ministry comments earlier in the day. That might be a catalyst to watch for euro/yen," said Jeremy Stretch, markets strategist at Rabobank in London.
"Alternatively it could be a presumption that people are nervous and that is exacerbating volatility."
Other traders said there was massive yen-selling against the euro after Japanese Finance Minister Shoichi Nakagawa said currency internvention was an option open to authorities.
Central bank bids were seen in euro/yen, but not related to currency intervention, traders said.
The Fed's rate cut has also raised pressure on the Bank of Japan to ease policy at a two-day meeting that ends on Friday.
Two-thirds of economists polled by Reuters this week expect the Japanese central bank to cut benchmark rates from the current 0.3 percent. (Additional reporting by Veronica Brown, editing by Mike Peacock)