FOREX-Euro recovers, c.banks eyed after RBA rate cut

* Euro recovers, sterling hits 2-1/2-year low

* RBA rate cut stokes speculation of cuts by other c.banks

* Pound stung by reports of RBS emergency funding

By Naomi Tajitsu

LONDON, Oct 7 (Reuters) - The euro rose on Tuesday on growing speculation that some central banks may follow a surprisingly big interest rate cut by the Reserve Bank of Australia and lower their own rates to stem economic deterioration.

Sterling hit a 2-1/2-year low after talk that the Royal Bank of Scotland was seeking government funding raised concerns about troubles in the UK banking sector.

The yen fell after the RBA's stunning rate cut decision, but investors remained wary of taking on risky trades that involve selling the yen for higher-yielding currencies. Markets brushed off the Bank of Japan's decision to hold interest rates at 0.5 percent.

The RBA's 1 percentage point rate cut ultimately boosted the Australian dollar and ramped up expectations that other central banks may also lower rates as the global banking sector screams for help to deal with the credit crisis.

European Union finance ministers were meeting in Luxembourg on Tuesday to hammer out ways to alleviate market turmoil, instil confidence in the banking system and ensure that savers do not lose money on their deposits [nPEK327881].

The meeting comes ahead of a gathering of finance ministers from the Group of Seven industrialised countries in Washington on Friday.

Analysts said the RBA's move -- which trumped expectations for a 50 basis point cut -- had raised the possibility of monetary loosening by other central banks, particularly the Bank of England, which holds a policy meeting this week.

"The focus is on the RBA and what it has done for rate expectations elsewhere," said Adam Cole, global head of currency strategy at RBC. "The risk of larger moves by central banks has risen significantly."

The euro was up 0.5 percent to $1.3559 by 0813 GMT, pulling away from a 14-month low of $1.3441 hit on Reuters data on Tuesday, when escalating worries about the health of European banks had pummelled the single currency.

Sterling fell as low as $1.7322, its weakest since April 2006, after Royal Bank of Scotland shares (RBS.L: Quote, Profile, Research, Stock Buzz) tumbled 30 percent on reports of talks for government funding, underlining turmoil in the financial sector [nL72038].

FOCUS ON BANKS, C.BANKS The BoE is expected to cut rates by 25 basis points from 5.0 percent on Thursday, according to a Reuters poll last week. But some in the market see a possibility of a 50 basis point cut, with some analysts arguing that the banking crisis and a deteriorating economy should take the front seat, rather than inflation risks.

Currencies were initially boosted by an early rise in European shares , but trimmed gains after equities fell into negative territory.

The Australian dollar was unchanged at $0.7200, after intially diving to a four-year low under $0.7000 immediately after the RBA announced its rate cut [nSP375711].

The yen stumbled across the board, boosting the dollar a touch at 102.00 yen, off a six-month low of 100.21 touched on Monday.

The Japanese currency slipped against other currencies, pushing the euro up around 1 percent , while the Australian dollar was up roughly 1 percent.

Analysts said that the RBA's decision may have increased the possibility of a hefty BoE rate cut, while adding that the chances of an emergency cut by the European Central Bank were low, at least for now.

"Policymakers ... particularly in Europe tend not to rush into things and hopes of some coordinated rate cutting either ahead of or following this weekend's G7 meeting may prove misplaced," analysts at Calyon said in a research note. Analysts said that markets were awaiting a speech by ECB President Jean-Claude Trichet later in the day to see if he will offer any clues into the central bank's rate outlook, adding that any suggestion that a rate cut may come soon could boost the euro.

"Whilst Trichet's more dovish stance following last week's ECB meeting prompted a sell off of the euro, the reaction to the Australian decision indicates that if he does hint at possible rate cuts the EUR should rally," they said.

(Editing by David Stamp) ((naomi.tajitsu@reuters.com; Tel: +44207 542 5830, Reuters Messaging: naomi.tajitsu.reuters.com@reuters.net))