LONDON: Sterling slipped to a five-week low against the euro on Monday as expectations of rising euro zone interest rates supported the single currency, although a downgrade of Greek sovereign debt capped further euro gains.
Some traders said euro selling demand from a US bank in early London trade helped to limit the single currency's rally, after it jumped last week when European Central Bank President Jean-Claude Trichet said euro zone rates may rise next month.
ECB rate speculation continued to bolster the euro, but Moody's three-notch downgrade of Greece reminded investors that higher rates may harm euro zone countries suffering from debt problems.
The pound has also gained broadly on speculation the Bank of England may raise rates around mid-year, but analysts said its upward momentum had lost some steam, and that euro rate expectations could further boost euro/sterling.
The BoE holds a policy-setting meeting this week.
Inflation-fighting rhetoric from the ECB expanded the spread between benchmark two-year German and UK government bonds, the most sensitive maturity to official rate moves, to around 38 basis points last week, their widest since October.
There remained near those levels on Monday, and analysts said this would support the euro versus the pound.
"Widening yield spreads could put more upward pressure on euro/sterling," said John Hydeskov, sterling strategist at Danske.
"Euro/sterling could rise a bit more if Trichet keeps up his hawkish stance on rates.
Trichet holds a press conference later in the day.
The euro rose as high as 86.08 pence in early London trade, its highest since late January, before pulling back to 85.83 pence by 0900 GMT.
Sterling edged up 0.1 percent on the day to $1.6298 against a broadly weak dollar.
"Cable is bid at the moment on the back of euro/sterling selling," a London trader said.
Speculation the BoE may raise rates in June or July has kept the pound in range of a 13-month high of $1.6344 hit last week.
Still, some market participants said upcoming gilt redemptions put the pound at some risk of selling as it could spark some repatriation flows away from the UK currency.
While markets see essentially no chance of a BoE rate rise this week, focus will be on whether the minutes from the gathering, due later this month, show more policymakers vote to tighten policy.
Analysts are concerned about the vulnerability of the UK economy to tighter monetary policy as disposable incomes could already be squeezed by the government's harsh austerity measures and by surging commodity prices.
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