* Sterling falls vs euro on UK CPI data, better German ZEW * UK inflation fall raises chances of more QE in Feb * Pound gains vs weaker dollar after China GDP data * M&A news supports sterling vs yen By Jessica Mortimer LONDON, Jan 17 (Reuters) - Sterling fell against the euro on Tuesday as a slide in UK inflation increased the chances that the Bank of England will ease monetary policy further, while a German sentiment survey improved markedly, buoying the single currency. But the pound rose against a weaker dollar in tandem with gains in the euro and other riskier currencies after data showed China's economy slowed less than expected in the fourth quarter, easing worries about the global economy. British inflation fell sharply in December, with the annual CPI rate dropping to 4.2 percent from 4.8 percent in November, supporting the Bank of England's view that consumer price inflation may have peaked. The weaker reading will add to expectations the BoE will increase asset purchases under its quantitative easing programme next month. Clear evidence of falling prices is a precondition for some BoE policymakers to back QE expansion. "The lower CPI is, the more ammunition it gives the BoE to do more QE, and we are approaching February when most people think the Bank will increase asset purchases," said Gavin Friend, currency strategist at nabCapital. The euro rose 0.5 percent to 83.09 pence, having risen above its 21-day moving average to hit a high for the day of 83.19, though traders reported large offers around 83.20-83.30 pence that could hamper its gains. The single currency was supported as the ZEW German economic sentiment index unexpectedly jumped to -21.6 in January from -53.8 in December, its biggest ever rise though it remained in negative territory. Many analysts were sceptical about how much further the euro could rise, however, with concerns about the euro zone debt crisis seen as likely to keep weighing on the single currency. On Monday, ratings agency Standard & Poor's cut its credit rating on the European Financial Stability Facility, the euro zone's rescue fund, in another blow to efforts to fight the crisis. It followed a mass downgrade of euro zone countries last week. Stiff resistance for sterling was expected at last week's high of 83.76 pence, while it stayed not far from its recent 16-month low of 82.22 pence. Many analysts expect euro zone worries to push the euro back below this trough towards the 80 pence mark. UK ECONOMIC WORRIES Investors were mindful of UK economic weakness, with recent data pointing to a high risk of recession. Some think that in the weeks to come data may weigh more heavily on sterling, which late last year was largely immune to UK worries as investors sought alternatives to euro zone assets. "This week is one where the international context is easing somewhat, with reassuring news out of China and a relatively calm digestion of the S&P downgrades, so the market is refocusing on domestic considerations," said Audrey Childe-Freeman, head of currency strategy at JP Morgan Private Bank. "Sterling is suffering as the UK economic picture is poor." UK labour market data on Wednesday and retail sales data on Friday could weigh on the pound further if they add to the picture of an increasingly fragile economy. "One of the potential triggers for a squeeze higher in euro crosses could be evidence of economic weakness outside of the euro zone. In this regard, sterling looks particularly vulnerable against the euro in the very near term," Citi analysts said in a note to clients. Against the dollar, sterling rose 0.4 percent to $1.5379, pulling away from Friday's trough of $1.5234, its lowest level since July 2010. Its next target is Friday's high of $1.5410, where traders cited stop loss orders, though they also reported offers above $1.5400 that may stem its gains. The pound rose against the yen, with traders citing support from M&A news as Japan's SMFG and Sumitomo Corp confirmed that they were buying the aircraft-leasing business of RBS in a deal worth $7.3 billion. But sterling also hit its lowest in around 27 years against the Australian dollar, which rose broadly on the China data, at A$1.4715.

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