* Sterling extends gains, hits three-week high vs dollar * Pound supported after Thursday's dramatic rally * Sterling set to end week higher vs major rivals
By Naomi Tajitsu
LONDON, Oct 16 (Reuters) - Sterling hit a three-week high against the dollar on Friday, extending the previous day's broad, dramatic gains as traders cut short pound positions after many reckoned earlier bets against the currency were overdone.
After a rollercoaster week in which the pound hit a 6 1/2-month low against the euro and multi-month troughs against several other currencies, sterling was set to end higher against its major rivals.
The pound rose to $1.6401 in Asian trade, a day after the market took talk of UK-related M&A activity and comments from a Bank of England policymaker that quantitative easing was working as an opportunity to cover short positions.
Traders continued to pick up the pound after it posted its biggest one-day gain against a basket of currencies in nearly a year on Thursday.
Short covering has breathed some life into the pound, which has come under heavy pressure in recent weeks, battered across the board on the view that UK interest rates will stay low and public finances will deteriorate further.
Sterling gave up some of its gains against the dollar and the euro in early London trade but some market participants said the currency may find support around current levels for now.
"It's possible the market is still piggy-backing on the M&A talk," said Geoffrey Yu, currency analyst at UBS in London.
"But there's been no new news today, so there's been a bit of a pullback."
Talk on Thursday that Qatar's sovereign wealth fund was planning a renewed offer for British supermarket chain J Sainsbury had helped spur sterling demand.
Remarks by BoE Monetary Policy Committee member Paul Fisher in a Financial Times interview on Thursday that the central bank's interest rate cuts and injections of money into the economy via asset purchases were working also helped the pound.
By 0801 GMT, sterling traded 0.3 percent higher at $1.6310, after slipping to the day's low as $1.6253.
It extended gains against the euro, which fell 0.4 percent to 91.45 pence. Earlier in the day, it hit a two-week low of 91.17 pence. Earlier in the week, the euro had hit a 6 1/2-month high of 94.13 pence.
Against a currency basket sterling rose to 79.20, pulling further away from a six-month low of 76.80 hit earlier in the week.
Sterling hit a three-week high around 148.80 yen.
Traders said the pound trimmed gains in London after sterling/dollar stop-loss orders were triggered at $1.6300. A slide in the Australian dollar, which along with sterling is considered a high-risk currency, also put some selling pressure on the pound.
Still, some said the pound would be supported as the market on Thursday had taken on fresh long positions in sterling, particularly against currencies other than the dollar, and were willing to hold on to those positions for now.
"I favour buying (sterling/dollar) on dips at the moment," a London trader said. "I fancy another look at $1.6400."
Sterling's correction, which began on Thursday, followed a hefty rise in speculator bets the currency would depreciate.
Data from the Commodity Futures Trading Commission on Friday showed currency speculators raised net pound short positions to 62,106 contracts in the latest week -- a record, analysts said -- from 47,826 contracts the week before.
For a graphic on the correlation between sterling positioning and its weakness against the euro, click on the link:
http://graphics.thomsonreuters.com/109/UK_CFTGBE1009.gif
(Editing by Nigel Stephenson)