* Sterling dips lower after Bank of England speeches
* Dollar bounces as Treasury yields hit 9-year highs
* Yields up on report of Trump favouring potential policy hawk
* Graphic: World FX rates in 2017 tmsnrt.rs/2egbfVh
By Fanny Potkin
LONDON, Oct 17 (Reuters) - The dollar held earlier gains and settled at a one-week high against a basket of major currencies on Tuesday, after a report that U.S. President Donald Trump was leaning towards picking a hawk as the next head of the Federal Reserve.
The greenback was supported by U.S. two-year Treasury yields hitting their highest levels in almost nine years on Monday, after it was reported that Trump was favouring Stanford economist John Taylor to head the Fed. They have stayed close to those levels on Tuesday.
MUFG currency economist Lee Hardman, in London, said the bank would “not be surprised” to see an initial jump in the dollar of between 3 and 5 percent should Taylor be chosen.
Taylor, an advocate of a rules-based approach to monetary policy, is seen as more hawkish than current Chair Janet Yellen and would therefore make a faster pace of tightening likely, boosting the dollar.
“A potential shift in strategy towards a more rules-based approach for setting policy would be seen as less supportive for financial markets and increase the likelihood of the Fed raising rates materially more in the coming years than is currently priced in,” Hardman said.
The dollar index — which measures the greenback against a basket of six major peers — rose on the report, and on Tuesday climbed half a percent to 93.549, its strongest since Oct. 9.
Trump’s shortlist also includes Jerome Powell, a Fed governor; Trump’s top economic adviser Gary Cohn; Yellen, whose term expires in February; and Kevin Warsh, a former Fed governor, sources have said, though investors say the chances of Warsh being selected have fallen.
Knocked by a stronger dollar, the euro slipped 0.3 percent to a one-week low of $1.1756, having fallen almost 3 percent since hitting a 2-1/2-year high last month.
It had no reaction to the release of German ZEW economic sentiment, which disappointed expectations in Germany and Europe by coming at 17.6 points, below its forecast of 20.1 points
Markets are wary of chasing the currency lower before a European Central Bank policy meeting next week.
“The EUR/USD is going to be rather stable for the time being, as investors weigh ongoing hawkish rhetoric from the Fed against an improving euro zone economy,” said Fawad Razaqzada, a technical analyst at Forex.com.
“However, the euro may be heading lower from here as the dollar remains fundamentally supported, with the Fed being the most hawkish central bank out there,” he said.
Sterling dropped to $1.32 for the first time in four days on Tuesday, after comments by Bank of England policymakers were interpreted by markets as broadly dovish.
Earlier on Tuesday, official data showed Britain’s inflation rate hit 3 percent, above the BoE’s 2 percent target but in line with expectations.
The greenback was flat at 112.21 yen after rising 0.3 percent late on Monday, when it pulled away from a three-week low of 111.650.
The Australian dollar was 0.14 percent lower at $0.7841 as its rally last week to a two-week high on upbeat Chinese data lost momentum.
For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets (Reporting by Jemima Kelly; Additional reporting by Shinichi Saoshiro in Tokyo; Editing by Catherine Evans)