Sterling knocked back by bond rout and inflation fears

* Graphic: World FX rates in 2020

* Graphic: Trade-weighted sterling since Brexit vote (Adds quote; updates rates)

By Joice Alves

LONDON, Feb 26 (Reuters) - Sterling fell against a stronger dollar on Friday, retreating from a three-year high touched earlier this week, as a rout in global bond markets sent yields flying and hurt the pound, while the Bank of England warned of inflation risks.

After rising above $1.42 on Wednesday, the pound touched its lowest since Feb 18 at $1.3890 in London morning trade, before recovering to stand 0.2% lower at $1.3982 by 1557 GMT

Versus the euro, the pound gained 0.1% to 86.80, after hitting a 10-day low of 87.30 pence.

Bank of England Chief Economist Andy Haldane warned on Friday of a risk that inflation will prove difficult to keep under control as the economy recovers from the pandemic.

Analysts also attributed sterling's fall to a sell-off in bond markets.

Benchmark U.S. Treasury yields vaulted to their highest since the pandemic began, driven by the prospect of accelerating growth and inflation that could trigger a faster rise in interest rates than many expect. Gilt yields also rose sharply on Friday.

"The aggressive Cable capitulation has seen macro and leveraged players retreating from an increasingly overbought market," said Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets, adding that the sterling correction started as the gap between 10-year and 2-year UK gilt yields tightened 2 basis points on Thursday.

Shaun Osborne, Chief FX Strategist at Scotiabank, said he expects sterling to climb back above $1.40 "once market activity normalises and long bets on the GBP resume, as it remains firmly supported by the country's vaccination campaign".

The pound has strengthened almost 3% this year versus the euro and 2.4% against the dollar as traders expect Britain's speedy vaccine roll-out will help the economy rebound from its biggest contraction in 300 years.

Relief over a Brexit trade deal and pushed back expectations for negative interest rates from the Bank of England had also supported sterling.

The pound was still on track for its fifth consecutive month of gains against the greenback and the euro, with analysts maintaining a positive outlook on the currency.

(Editing by William Maclean, Kirsten Donovan)

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