LONDON: Sterling rose on Monday against the dollar which broadly retreated after market players booked profits on its recent rally and also after US treasury yields slipped on the day.
But analysts said this move up would likely lose steam and sterling, which was still trading close to a four-month low against the dollar, could drop to its lowest in three years, given the widening interest rate differentials between the United States and Britain.
Recent US data has been robust and supported expectations the Federal Reserve would pare back its stimulus programme. In contrast, the Bank of England last week clearly signalled it was in no hurry to hike interest rates.
Sterling was up 0.3 percent at $1.4926, but still not far from a four-month low of $1.4855 struck on Friday.
Analysts said the pound was vulnerable to losses and could slip to its March low of $1.4832, below which it could test a three year low. A reported options expiry at $1.4900 could keep the currency pinned to that level.
"We have seen a pretty strong move down in sterling (in previous sessions) and that is why we are now seeing a bit of a recovery, but that is only marginal given the extent of the move lower," said Simon Smith, chief economist at FXPRO.
He expects losses in the pound to be sustained due to the divergence in policy stance between the Fed and the BoE.
The yield gap between 10-year US Treasuries and UK gilts was the widest since 2006 last week, pointing to more gains for the dollar.
The euro was flat on the day at 86.15 pence, staying below a recent high of 86.34 struck on Thursday.
The euro zone is Britain's biggest trading partner and is battling a recession. The European Central Bank last week pledged to keep rates at current levels, or even lower, to help spur economic recovery.
"Given the ECB has just adopted much stronger forward guidance for policymaking in the euro zone, the BoE is also likely to commit to keeping interest rates very low for an extended period," said Mansoor Mohiuddin, chief currency strategist at UBS.
Analysts said the preferred way to express a bearish view on sterling would be to sell it against the dollar.
Citi has initiated a short position in the pound against the dollar. It has entered into the trade at $1.4881 for a target of $1.45 and stop-losses at $1.5123.
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