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Pound gains as dollar takes a breather

LONDON, Oct 4 (Reuters) - The pound rose against the dollar for the first time in almost a week on Wednesday, in line with a retreat in the U.S. currency, and after a survey showed UK business activity was less subdued than initially feared in September.

The final reading of S&P Global UK Services Purchasing Managers' Index (PMI) fell in September to 49.3 from 49.5 in August, further below the 50 threshold for growth.

The reading was an eight-month low, but it topped a preliminary reading of 47.2 that shocked investors earlier in September.

The final PMI included responses from companies surveyed from Sept. 20 to Sept. 27 - days after data showed British inflation fell unexpectedly in August, as well as the Bank of England's surprise decision to leave interest rates unchanged on Sept. 21.

Sterling was last up 0.4% on the day against the dollar at $1.2123, having fallen for the last three trading days, although the rise in U.S. government bond yields meant this strength could be short lived.

The pound gained 0.1% against the euro to trade at 86.63 pence, but remained in sight of late September's four-month lows around 87 pence.

"With inflation cooling and concerns rising over a prolonged economic slowdown, the market is convinced that the BoE has reached the end of its hiking cycle, which is keeping pressure on the pound," City Index market strategist Fiona Cincotta said.

Money market traders believe there is a 22% chance of another rate hike from the BoE this year, but this would likely be the last increase for this monetary policy cycle.

Just three months ago, traders expected UK rates to peak above 6% around the middle of next year. One of the reasons the dollar has proven so resilient in recent weeks is the expectation that U.S. interest rates could rise at least once more this year and remain higher for longer than those in the UK.

​​"Buyers will need a close back above $1.22 to indicate that a low could be in place in the short term. This is where Friday’s bounce stalled as selling pressure revived," said IG chief market analyst Chris Beauchamp.

Against the yen, the pound rose 0.3%, moving clear of Tuesday's 10-week lows. The yen hit its lowest in a year against the dollar on Tuesday, before staging a sudden rally after having weakened past 150 per dollar - widely believed to be a level at which Japanese monetary authorities might intervene to shore up the currency.

A number of currency watchers said the turnaround in the yen on Tuesday was reminiscent of intervention, but that official buying was highly unlikely to be the driving force given the Ministry of Finance and the Bank of Japan's focus on volatility, rather than outright trading levels.

(Reporting by Amanda Cooper; Editing by Christina Fincher)