FOREX -Dollar off 2-month lows; Aussie on defensive ahead of RBA

* Dollar index holds steady, stays above 2-mth low

* Aussie sags ahead of RBA policy meeting on Tuesday

* Weak China HSBC PMI also weighs on Australian dollar

* Sterling nurses losses, May 7 election in focus (Updates prices, adds levels)

By Masayuki Kitano and Ian Chua

SINGAPORE/SYDNEY, May 4 (Reuters) - The Australian dollar slipped on Monday, dented by speculation the Reserve Bank of Australia may cut interest rates on Tuesday, while the U.S. dollar held steady in a respite from its recent selloff.

The Australian dollar briefly added to its losses after a private business survey showed that China's factories suffered their fastest drop in activity in a year in April.

The Australian dollar, which is seen as a liquid proxy for China plays due to Australia's large trade exposure to China, fell from around $0.7830 to as low as $0.7803 after the release of April's HSBC PMI.

The Aussie later pared its losses and last traded at $0.7829 , still down 0.3 percent on the day.

Besides the weak reading on Chinese factory activity, the Australian dollar was weighed down by ongoing speculation that the RBA might cut interest rates at its policy meeting on Tuesday, said Jeffrey Halley, FX trader for Saxo Capital Markets in Singapore.

Another headwind for the Australian dollar was euro-buying interest against the Aussie Halley said, adding that the Aussie dollar could gain some reprieve if the RBA were to keep interest rates steady on Tuesday.

"No (RBA) cut tomorrow can see a retracement to $0.7900 at least, possibly $0.8000."

The Aussie has slipped back since hitting a three-month high of $0.8077 last Wednesday, pressured in part by growing expectations that the RBA will cut interest rates to a record low 2.0 percent at its May 5 meeting.

The dollar index last traded at 95.275, staying above a two-month low of 94.399 set last Thursday.

The euro eased 0.1 percent to $1.1187, having backed off from a two-month high of $1.1290 set on Friday.

The dollar has retreated over the past few weeks as a string of disappointing U.S. data convinced investors that the Federal Reserve will be in no hurry to lift interest rates and prompted them to unwind bullish bets on the greenback.

While the dollar may soften further in the short-term, the "strong dollar" trend is likely to remain intact, said Stefan Hofer, chief investment adviser Asia for BNP Paribas Wealth Management in Hong Kong.

"There is a widening perception in the market that the strong dollar is becoming a tangible drag on U.S. exports, and this was reinforced by the recent Q1 2015 GDP release. However, the longer-term perspective remains that the U.S. is on track to deliver a rate hike, most likely in September," Hofer said.

Against the yen, the dollar eased 0.1 percent to 120.08 yen . The greenback, however, has recovered from a one-month low of 118.50 yen set on Thursday.

Sterling edged up 0.1 percent to $1.5159, nursing its losses from Friday, when it shed more than 1 percent.

Already on tenterhooks ahead of the May 7 general election, the pound was further stung on Friday by a survey showing British manufacturing growth slowed sharply in April.

"We expect sterling to remain under pressure at least until the political fog lifts," analysts at ANZ wrote in a note to clients, recommending investors stay short sterling against the Australian, New Zealand and Canadian dollars.

Britons will vote on Thursday in what is expected to be the tightest election in decades. A YouGov opinion poll for the Sun newspaper published on Sunday showed Prime Minister David Cameron's Conservative Party had a mere one-point lead over the opposition Labour Party.