* Sterling retreats against dollar, euro after UK PMI data
* Euro pares gains versus dollar as European shares slip
* Yen holds near 7-week high vs dollar (Recasts, changeds dateline, byline previous TOKYO)
By Emelia Sithole-Matarise
LONDON, Sept 1 (Reuters) - Sterling fell against the dollar and the euro Tuesday after an unexpected dip in UK manufacturing activity in August, stoking concerns about the pace of the recovery in the British economy.
The headline UK manufacturing purchasing managers' index fell to 49.7 last month from a downwardly-revised 50.2 in July. That was the first fall since February and well below the consensus forecast for a rise to 51.5.
The euro regained ground against the UK currency but pared gains versus the dollar as European shares fell 1 percent even as an earlier report showed the euro zone purchasing managers' index rose to 48.2 against expectations for a 47.9 reading and German unemployment unexpectedly fell in August.
The euro zone data comes before a European Central Bank policy meeting on Thursday widely expected to keep benchmark rates steady at a historic low of 1 percent with focus on policymakers' outlook on the economy.
"People were expecting an improvement (in UK PMI) but the decline ... is a downside surprise but I don't think its going to be the start of a new downward trend in the manufacturing PMI for the UK," said Ardash Sinha, a currency strategist at Barclays Capital in London.
Sterling fell 0.2 percent on the day to $1.6249 by 0912 GMT, within a whisker of the session's trough of $1.6242 and was 0.3 percent lower against the euro at 88.30 pence.
The dollar pared earlier losses against the euro after the pullback in European shares but market participants said the U.S. currency to stay on the back foot with U.S. ISM manufacturing data due at 1400 GMT likely to support appetite for riskier assets.
"In the U.S. our economists are going for (a PMI) of 53, higher than consensus so in general that should continue to support risky assets and some extent be negative for the dollar and the yen," said Sinha.
At 0918 GMT, the euro was up 0.1 percent against the dollar at $1.4347 and 0.2 percent stronger on the day versus yen at 133.57 yen.
The dollar index, which measures the dollar's value against a basket of currencies was little changed around 78.13.
Among higher yielding currencies, the Australian dollar lost some ground against the U.S. dollar after its central bank sounded less hawkish than some had anticipated.
The Australian dollar fell 0.9 percent on the day to $0.8370, after edging up close to last month's 11-month peak at $0.8479 ahead of the Reserve Bank of Australia policy statement.
The RBA, holding its cash rate at 3.0 percent as expected, said the current low level of rates was appropriate, countering speculation it would adopt an explicit tightening bias.
"It looks like people who had aggressively priced in the idea that Australia would increase rates soon trimmed their holdings of the Aussie slightly," said Ayako Sera, market strategist at Sumitomo Trust & Banking.
The yen held at 93.07 per dollar, little changed from late New York levels but below Monday's seven-week high of 92.54 set on trading platform EBS. (Additional reporting by )Kaori Kaneko; editing by Chris Pizzey)