* Sterling climbs to new 16-month high vs euro * Looming Spanish, Italian auctions keep investors on edge * UK more vulnerable vs dollar, U.S. NFP due 1330 GMT By Nia Williams LONDON, Jan 6 (Reuters) - Sterling rose to a fresh 16-month high against the euro on Friday and looked set to stay supported as investors concerned about euro zone sovereign funding pressures reached for the relative safety of the UK currency. The euro dropped to 82.39 pence, its lowest level since September 2010 before finding support from reported bids around 82.30-40 pence. It was last close to flat on the day at 82.49 pence. Market players said the pound's strength was down to euro zone woes rather than strong domestic fundamentals, even though data on Thursday showed a pick-up in UK service sector activity. Those figures were tempered on Friday by data showing UK house prices fell 0.9 percent on the month in December, confounding expectations of a modest improvement. There was little impact on the currency. "I think euro/sterling will continue to go lower. All the problems that have caused euro zone bond markets to sell off in the fourth quarter have not only not been resolved, they look set to intensify," said Neil Mellor, currency strategist at Bank of New York Mellon. "It comes back to the issue of ugly currencies. In terms of dollar, sterling and euro, sterling comes second best." Mellor said the euro could find decent support around the September 2010 low of 81.43 pence and below that around 80.65 pence, near the summer 2010 trough. Market players are likely to remain cautious ahead of Italian and Spanish debt auctions next week that are seen as those countries' first major refinancing tests of 2012. Analysts said many investors preferred to invest in UK rather than euro zone government debt, boosting sterling, given UK deficit-cutting austerity measures that are already in place and the Bank of England's independent monetary policy. There was solid demand at UK gilt auctions earlier in the week, and BoE data also showed foreign investors increased their gilt holdings by 16.3 billion pounds in November, the largest monthly rise since September 2008. VULNERABLE VS DOLLAR Although the pound was buoyant versus the euro, some strategists said it had potential to weaken against the dollar. U.S. non-farm payrolls, due at 1330 GMT are forecast to show 150,000 jobs added, and a stronger-than-expected number could prompt investors to buy the greenback on the view U.S. economic activity is picking up faster than in the UK. Sterling was last up 0.1 percent against the dollar at $1.5494. Technical analysts said a break below the 21-day moving average around $1.5562 the previous day had left the pound vulnerable to a test of $1.54. "If there is a strong number relative to expectations we could see further downside in cable because people would see the U.S. economy as doing better than the European economy in general. We shouldn't forget the UK is part of Europe," said Paul Robinson, head of European FX research at Barclays Capital. Morgan Stanley strategists said Friday's weak house price data added to the overall picture of a fragile UK economy and lowered the stop loss on their short sterling/dollar trade to $1.5585, with a target of $1.5280.

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