* Sterling creeps up vs dollar, rebounds from 7-week low
* Moody's threat on UK bank downgrades initially slaps GBP
* Pound recovers as investors cut short positions
By Naomi Tajitsu
LONDON, May 24 (Reuters) - Sterling bounced off a seven-week low and edged higher against the dollar on Tuesday as traders covered speculative short positions after Moody's threatened to cut its ratings on some UK banks, but analysts said the currency may continue to struggle.
Traders said small euro gains against the dollar also boosted the pound against the greenback. Analysts said sterling's weakness versus the euro suggested the UK currency may remain vulnerable on concerns about the banking sector, which come as the economy posts only a modest recovery.
Ratings agency Moody's said it may downgrade 14 UK banks because regulators appear less willing to bail them out in the future. [ID:nLDE74N099]
Analysts said sterling was vulnerable to more losses given the possibility of ratings cuts to some of the world's leading banks, adding that a fall in sterling below the psychologically important $1.60 level was possible before month-end.
"Sterling will be fragile as investors take a closer look at what Moody's is saying about UK banks," said Michael Derks, currency strategist at FXPro.
"Depending on how many banks may be downgraded, the bigger and broader the downgrade, the impact on sterling could be great," he said, adding that he saw a fall to $1.58 in a month.
By 1103 GMT, sterling GBP=D4 was up 0.2 percent on the day at $1.6155.
It clawed up from $1.6055 earlier in the day, its weakest since early April, as investors had sold the pound on speculation that Moody's would make an announcement on UK banks.
Market participants said the announcement itself had prompted traders to cover those short positions, although upside resistance loomed at $1.6162, the pound's 100-day moving average.
Traders said sterling sentiment continued to sour after its retreat from $1.6747 hit in April, its strongest since late 2010, and that selling may accelerate on a break below $1.60.
"USD sellers are getting in here, although more are holding out for a break below $1.60," said Lee Mcdarby, head of dealing for corporate and institutional treasury at Investec.
The euro EURGBP=D4 was up 0.2 percent on the day at 87.30 pence, tracking the single currency's gains against the dollar.
Mcdarby added that large orders to buy euros were building up once again around 1.15 euros per sterling, or just below 87 pence -- a level closely watched by UK corporates as a key budget rate -- by those who missed out on the chance to buy when the euro fell to that level on Monday.
The pound brushed off figures showing the worst borrowing tally on record for the month of April. UK public sector net borrowing came in at 7.7 billion pounds last month, around 2.5 billion pounds higher than a year ago. [ID:nLDE74N10M]
Investors offered limited reaction to comments from Bank of England policymaker Martin Weale, who was quoted in a UK newspaper as saying that raising interest rates sooner may mean they would not need to rise so high in due course. [ID:nLAK002792]
Given concerns about a slow economic recovery, short-term interest rate markets have been pricing out a rate rise in 2011, and see a 25 basis point tightening in early 2012 <ICAP/SONIA> BOEWATCH. (Reporting by Naomi Tajitsu; Editing by Hugh Lawson)