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Sterling clings on to gains after Kwarteng's tax U-turn

(Updates prices, adds quotes)

LONDON, Oct 4 (Reuters) - The pound gave up much of its early gains on Tuesday but remained narrowly in the green after finance minister Kwasi Kwarteng's dramatic U-turn on some tax cuts.

Sterling was last up 0.1% to $1.1331, down from a session high of $1.1428. The euro was up 0.54% against the pound at 87.25 pence.

The pound dropped to a record low of $1.0327 on Sep. 26 and bond prices tumbled after Kwarteng unveiled plans to slash taxes, particularly for the rich, and ramp up borrowing.

The dire market reaction and a likely revolt by his own lawmakers forced Kwarteng into a U-turn on Monday. He dropped plans to get rid of the 45% top rate of income tax, one day into the ruling Conservative Party's annual conference.

The Bank of England (BoE) last week intervened in the bond market following a dramatic plunge in long-dated gilts, pushing the pound up from its record lows.

The pound then rose around 1.7% on Monday after Kwarteng announced his policy reversal, according to Refinitiv data. It was on track to rise for its sixth straight session on Tuesday.

"Sterling is beginning to find a secure footing after a week of volatility provoked by the policy announcements made by Chancellor Kwasi Kwarteng," Harry Adams, chief executive officer at Argentex Group, said.

Adam Cole, head of foreign exchange strategy at RBC Capital Markets, said a fall in the dollar was the main driver of movements in currency markets on Tuesday.

The U.S. dollar index was last down 0.31% to 111.22 following a drop in U.S. Treasury yields.

U.S. yields, which move inversely to prices, fell after survey data showed the U.S. manufacturing sector slowed in September. The weaker data caused traders to bet the Federal Reserve may raise interest rates less than previously expected.

The yield on the benchmark 10-year U.S. Treasury note was down around 6 basis points on Tuesday to 3.593%, after rising above 4% last week. The Bank of England's intervention last Wednesday and Kwarteng's U-turn also pulled global bond yields lower.

"There will be days like today when the dollar is under pressure," Cole said. "We could see that again in the coming days if the more optimistic outlook for assets continues."

Yields on the benchmark UK 10-year government bond fell more than 10 basis points to 3.814% as investors digested Kwarteng's decision and the BoE's bond purchases.

Britain sold 2.5 billion pounds ($2.84 billion) of 40-year benchmark government bonds

at an average yield of 3.371%

on Tuesday. That was the highest yield for any gilt sold at auction since 2014, suggesting investors have demanded steep discounts to buy long-dated UK debt.

Despite the recent rally across UK assets, analysts said the outlook for sterling remained gloomy. Adams said he expected the Conservative Party conference to drive further volatility.

"We anticipate sterling to remain highly responsive to the notion of any further changes in government policy," he said. "There is no realistic scenario whereby sterling enjoys a straightforward recovery."

The pound has fallen more than 16% this year as the dollar has surged on the back of the U.S. Federal Reserve's aggressive rate hikes, and as doubts have mounted about Britain's economy and policies. Meanwhile, the dollar index has risen more than 18%, with higher interest rates making U.S. assets look more attractive.

($1 = 0.8773 pounds) (Reporting by Harry Robertson Editing by Mark Potter and Peter Graff)