THE POUND may gain against the euro this week on expectations that the UK economy will start to rebound while the outlook darkens for growth in Germany and France.

On Friday, the pound rose against the euro to its highest yet at pounds 0.6801 per euro, from pounds 0.6848 late on Thursday. That's a 1.5 per cent jump in a week. The EU's currency began trading on 4 January at an initial rate of 0.7055. Sterling fell to $1.6245 from $1.6353 as the dollar surged against the euro and the yen.

"The prospects have improved for the UK [after the Bank of England's five interest-rate cuts]," said Jane Foley, a currency strategist at Barclays Capital. "Sterling has benefited from perception that the sharp downturn in interest rates will help revive the economy." She sees sterling moving to 0.66 euros in six months' time.

UK reports in the past week brought news of a surprise drop in the number of jobless, faster than expected inflation and a rebound in retail sales. That has some investors questioning the likelihood of the Bank of England cutting rates next month.

One hurdle to sterling's advance could be if growth turns out weaker in the final months of 1998 than the Government first figured. Tuesday brings the release of the second estimate of fourth-quarter gross domestic product and if revised down, fears of a recession could resurface.

"It will definitely be revised down," said Glenn Davies, chief economist at Credit Lyonnais Securities, who's expecting the Bank of England to hold rates steady at next month's meeting. But, if the rate is revised down further, the BOE may cut rates again in March, he said.

"We changed our view after the labour report," said Mark Wall, an economist at Deutsche Bank, where analysts had originally expected a March cut. "It could give the BOE an excuse to stay on hold."

Still, the Bank of England won't hesitate to cut interest rates further if the world economic outlook worsens, central bank governor Eddie George said on Thursday. "If the global economic prospect, and net external demand in the industrial countries, were to deteriorate further, then it would be right to contemplate further moves in the same direction," he said.

Meanwhile, the two biggest economies in the euro zone are grappling with faltering growth. The Bundesbank said on Friday that the German economy contracted in the fourth quarter by 0.4 per cent. In France, industrial output slid 1.6 per cent in December, falling more than analysts predicted and slipping at its fastest rate since November 1997.

The European Central Bank may soon have to trim rates to restore growth. The ECB left its benchmark refinancing rate at 3 per cent on Thursday. If euro rates decline, it would widen the gap with the UK and makes sterling more attractive. A three-month UK deposit presently pays 5.44 per cent while a euro deposit yields 3.08 per cent. In New York, the dollar surged 1 per cent on Friday to more than Y121 and to its best level versus the euro. The US reported a surprise narrowing of the trade deficit, meaning companies have fewer dollars to convert into home currencies. That combined with surging US growth and stocks makes the dollar unbeatable against the major currencies, investors say.