* Sterling extends gains, hits three-week high vs dollar * Pound further supported after Thursday's 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 dramatic gains as traders who had bet on further falls in the pummelled pound rushed to cover their positions.
The pound was poised to end higher against major currencies in a week marked by whipsaw trade, which saw sterling claw back from an earlier 6 1/2-month low versus the euro and its weakest in nearly five months against the dollar.
The UK currency extended gains a day after the market took talk of overseas interest in buying a big UK supermarket chain and a Bank of England policymaker's comments that quantitative easing was working as opportunities 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.
"We're still feeling the resonance from yesterday's rally," said Jane Foley, research director at Forex.com in London.
Short covering has breathed life into the pound, which has been battered in recent weeks on expectations UK interest rates will stay low and public finances will deteriorate further.
Helping the pound were remarks by BoE board 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.
But Foley said Fisher had said nothing new about whether the BoE would extend its quantitative easing programme -- a factor in recent sterling weakness -- and that the interview's market impact was exaggerated by demand to cut short positions.
By 1322 GMT, sterling was up 0.5 percent at $1.6353, after climbing to $1.6401, its highest since late September.
"I favour buying (sterling/dollar) on dips at the moment," a London trader said. "I fancy another look at $1.6400."
The pound was on track to climb roughly 3 percent on the week, its best weekly performance since mid-June, while euro/sterling was heading towards a 2 percent fall.
Sterling 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 90.96 pence, falling from a 6 1/2-month high of 94.13 pence touched on Tuesday.
Against a currency basket sterling hit 79.60, rising from a six-month low of 76.80 hit on Tuesday. On Thursday it rose 1.9 percent, its best daily performance since January.
It hit a three-week high around 149.35 yen.
VOLUMES, VOLATILITY RISE
Sterling's rollercoaster ride this week saw a spike up in the volume of sterling/dollar trades, which soared to around 17,500 on Thursday according to Reuters data, significantly higher than average levels around 10,000.
Volatility has also jumped, with one-month sterling/dollar options rising to around 12.75 percent on Friday, its highest in two months, and a sign that the pound may undergo further aggressive moves against the greenback. Volatility has risen roughly 1 percentage point from earlier in the week. Phil Roberts, technical strategist at Barclays Capital, said a sterling/dollar close above $1.6125 on Friday would imply the downward correction from the 2009 high around $1.70 is over, while a euro/sterling close below 90.75 pence may confirm the tide has turned for the pound.
For a story on euro/sterling technical levels, click on
Foley at Forex.com said the market may have run ahead of itself in optimism about sterling's prospects, particularly ahead of data on UK third-quarter growth and public sector borrowing due next week.
"If the borrowing data and the GDP data are poor, there's a good chance that QE will not be off the table," she said, adding that dismal figures may put sterling back on its losing track.
Sterling's rebound followed a hefty rise in speculator bets the currency would depreciate, which analysts say hit their highest on record last week.
For a graphic on the correlation between sterling positioning and its weakness against the euro, click on: http://graphics.thomsonreuters.com/109/UK_CFTGBE1009.gif
(Editing by Nigel Stephenson)