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FOREX-Sterling slumps on dovish inflation report; euro holds gains vs dollar

* Sterling broadly weaker, hits 1-month low vs dollar on BoE report

* Euro recovers from one-month low below $1.37

* Yen strengthens vs dollar and euro (Adds U.S. PPI data, changes byline, dateline, previous LONDON)

By Daniel Bases

NEW YORK, May 14 (Reuters) - The British pound fell from a 16-month high versus the euro and dropped to a one-month low against the dollar on Wednesday after the Bank of England surprised investors by saying it has no plans for near-term monetary tightening.

"(The pound) had been the cat's meow up until this morning's employment numbers and BOE inflation report. The market was clearly positioned for a more aggressive MPC (Monetary Policy Committee) and they didn't get that," said Lane Newman, director of foreign exchange for ING Capital Markets.

The euro held modest gains against the dollar while slumping to a 2-1/2 month trough against the yen, despite being helped by steady purchases by Asian central banks keen to curb the strength of their own currencies.

Central bank interventions such as those by South Korea and China have stemmed the euro's losses in the face of growing expectations the European Central Bank will loosen monetary policy in June in an effort to stem deflationary pressures.

"It is a sell into the rally for the euro/dollar on the assumption that the ECB goes for negatives rates and that reverse managers will be looking to reduce some of their euro-cash exposure to avoid deposits in negative interest rates," said Sebastian Galy, senior currency strategist at Societe Generale in New York.

Reuters on Wednesday quoted sources as saying the ECB was preparing a package of policy options for its June meeting, including cuts in all its interest rates and targeted measures aimed at boosting lending to small- and mid-sized firms.

Unexpectedly higher U.S. producer price inflation data for April, the largest increase in 1-1/2 years, caused some short-lived dollar buying.

The euro rose above the $1.3700 level but retested it three times where it now seems to be finding support. It was last trading at $1.3716, up 0.1 percent.

Against sterling, the euro rose 0.37 percent to 81.75 pence, rebounding from a fresh 16-month low of 81.26 pence.

The euro hit a 2-1/2 month low of 139.44 yen, down 0.45 percent. The greenback dropped 0.50 percent to 101.72 yen .

Sterling lost ground after the Bank of England deflated expectations it might raise interest rates in less than a year's time, saying Britain's economic recovery was still in its early stages. It also noted a strong bounce-back in the job market and lowered its forecast for unemployment for the next couple of years.

Sterling hit a one-month low of $1.6753 after the report was released, from around $1.6820. It was last trading at $1.6785, down 0.26 percent.

In the report, the BoE noted that sterling appreciation was putting downward pressure on inflation.

(Additional reporting by Patrick Graham and Anirban Nag in London, Ian Chua in Sydney and Masayuki Kitano in Singapore; Editing by Paul Simao)