RTRS:Pound stays near 3-1/2 year high against euro
* Sterling hovers near highest vs euro since Oct 2008
* More gains expected as Spain worries dent the euro
* Pound seen shrugging off weak UK data
By Jessica Mortimer
LONDON, July 20 (Reuters) - Sterling stayed close to its strongest level in more than 3-1/2 years against a shaky euro on Friday, despite public finances data which was expected to show a dismal outlook for the British economy, as investors steered clear of euro zone assets.
The pound has benefited from investors looking to cut exposure to peripheral euro zone debt by buying UK government bonds, considered a relative safe haven from the crisis, and more gains against the euro were expected.
The German parliament's expected approval of a Spanish banking bailout was not expected to halt the rise in Spain's borrowing costs, especially after weak demand for its bonds at an auction on Thursday.
The euro was up 0.1 percent at 78.14 pence, staying not far from a low of 77.91 pence struck on Thursday, its weakest level since October 2008.
Worries about the euro zone debt crisis were expected to keep the pound gaining despite the British public finances data, due at 0830 GMT, which was expected to show another big monthly deficit.
"The pound can seemingly weather any weak data that is thrown at it ... The only time we get any movement is when data overshoots expectations," said Richard Driver, currency strategist at CaxtonFX.
"The market is more focused on the euro zone than it ever has been and that benefits sterling." He added he expected the euro would now fall towards 77.45 pence after breaking below 78 pence.
Buoyed by the pound's gains against the euro, sterling's trade-weighted index was at 84.6, matching a high hit in mid-May which marked its strongest in nearly three years.
The public finances data is not expected to be a market mover for sterling, analysts said, though it will keep alive concerns that a weakening economy will make the government's task of reducing the deficit much tougher.
Earlier this week, the pound shrugged off weak retail sales figures, which gave further evidence the UK economy is struggling to emerge from recession, as well as Bank of England minutes which raised the prospect of further monetary stimulus.
The International Monetary Fund said on Thursday that Britain should rein in its austerity programme and cut taxes or increase infrastructure spending if the economy has not regained momentum by early next year.
Against the dollar, sterling was down 0.2 percent at $1.5693. It tracked falls in the euro against the dollar, while some investors took profit on the pound's recent gains which took it to a one-month high of $1.5738 on Thursday.
