* Euro approaches last week's 4-month low vs dollar
* U.S./euro zone yield gap widens in dollar's favour
* Euro weaker on crosses, investors use it as funding currency (Adds comments, updates prices)
By Anirban Nag
LONDON, June 11 (Reuters) - The euro hovered near a four-month low versus the dollar and hit a 1-1/2 year trough against sterling on Wednesday, with the single currency under pressure due to a widening yield gap between euro zone bonds and their major peers.
A rise in U.S. yields on speculation that the U.S. Federal Reserve could raise interest rates sooner than previously expected has supported the dollar and put pressure on the euro this week.
The single currency has also been pegged back by the European Central Bank cutting interest rates last week - including imposing a negative rate on excess cash deposited with it - and launching other measures to ward off disinflation.
That has pushed down euro zone money market rates, eroding the euro's yield allure, and leading some investors to use it as a funding currency - one borrowed cheaply to buy a higher-yielding unit.
The euro fell 0.15 percent to $1.3525, nearing a four-month low of $1.3503 set last Thursday soon after the ECB cut rates to record lows. It was also down against the British pound, dropping to 80.54 pence, its lowest level since late 2012 after a good British jobs report.
The euro set a near seven-month low against the Australian dollar on Wednesday. It was last down 0.3 percent at A$1.4410 . Against the New Zealand dollar, the euro last fetched NZ$1.5834, having shed 1.4 percent this week.
"We are seeing a number of euro/crosses hit lows and among the G3 currencies we are seeing the euro becoming a funding currency," said Jeremy Stretch, head of currency strategy at CIBC World Markets.
"Against the dollar, we will see a slow grind towards the $1.35 level where there will be some support from sovereign players. Unless the U.S. Treasury yields shoot up, it's going to be a slow move down and not a sprint for the euro."
Jesper Bargmann, trading head for Nordea Bank in Singapore said that while the euro zone's current account surplus and deleveraging by European banks could lead to some demand for the euro, the currency is likely to head lower in the medium term.
"I think it will be a preferred funding currency in the medium term," he added.
FOCUS ON YIELDS
A strong U.S. jobs report on Friday, and hawkish comments from St. Louis Federal Reserve Bank President James Bullard on Monday have given a lift to U.S. yields this week and helped buoy the greenback against the euro.
According to Thomson Reuters data, the yield spread between two-year U.S. Treasuries and two-year German government bonds has risen to more than 37 basis points this week, its highest in seven years.
"Our outlook is that positive fundamentals in the U.S. mean positive U.S. assets and a positive outlook for the dollar," said Sandra Crowl, a member of the investment committee at France's Carmignac Gestion, which manages some 50 billion euros.
But she saw some potential still left in the rally in peripheral bond markets in Europe, a factor that has lent support to the common currency in the past few months.
The euro fell 0.4 percent versus the yen to 138.05 yen , while the dollar was lower at 101.90 yen, its lowest in 10 days.
A focal point for the yen is the Bank of Japan's two-day policy meeting on June 12-13. It is likely to keep monetary policy steady and may slightly revise up its assessment on overseas growth.
(Additional reporting by Patrick Graham; Editing by Catherine Evans)
- Europe News