(Rewrites throughout, adds background, poll story and comment)
By Saikat Chatterjee and Ritvik Carvalho
LONDON, July 7 (Reuters) - Sterling was set for its worst week in four on Friday after below-forecast output and trade data capped a run of downbeat readings of Britain's economy, adding to questions over the Bank of England's shifting interest rate stance.
Data showing an unexpected contraction in British industrial output in May put sterling on the defensive from the start of European trade and the currency extended its losses against the dollar after a strong U.S. labour market report.
By 1530 GMT, the pound was down over half a percent at $1.2879, having fallen as low as $1.2867. It was 0.4 percent lower at 88.41 pence per euro.
The numbers also flagged shrinkage in the UK manufacturing and construction sectors, and echoed surveys of purchasing managers earlier in the week that were tepid across the board.
Added to a widening trade deficit, the readings raised doubts about whether the BoE will follow through on recent hawkish rhetoric and soon raise interest rates that have stayed at record lows for 10 years.
"Given the soft data this week, I think a UK rate hike is increasingly becoming a 2018 story," Viraj Patel, an FX strategist at ING in London, said.
Strategists at Nomura, however, have predicted the BoE will hike rates in August.
Strategists have been split over how soon the BoE is likely to raise rates since Governor Mark Carney and Chief Economist Andy Haldane signalled a turn in the Bank's thinking last week.
Those sceptical of an imminent rate rise cite reasons ranging from risks to an economy facing two years of Brexit negotiations, to the arrival of Silvana Tenreyro as a seemingly dovish member of the Bank's rate-setting committee.
Investors will look to next week's hearing on the central bank's latest inflation report for further clues on its willingness to look through a rise in prices that has shot past its 2 percent target.
Sterling also pulled back from a six-week high against the yen hit earlier in the day after the Bank of Japan expanded its purchases of government bonds, easing monetary policy.
It last traded up 0.1 percent at 146.88 yen.
Foreign exchange strategists are more optimistic about the pound versus the dollar than they were at the start of 2017, with a majority becoming either less bearish or more bullish, according to a Reuters poll.
Median forecasts for the pound against the euro predict it will hover around the 88 pence mark well into 2018. But Martin Arnold, FX strategist at ETF Securities, said sterling would likely rise to 84 pence per euro over the next year.
"The combination of the sharp change in mindset from the BoE and the continued measured approach by the European Central Bank is going to see euro/sterling come down," he said. (Additional reporting by the London Markets Team; Editing by Gareth Jones and Jane Merriman)