LONDON: Sterling hit a new 3-1/2 year high against the euro on Wednesday, bolstered by doubts about the currency bloc's ability to activate bailout funds to protect its troubled debtor states.
The euro fell to 78.87 pence in early trade, the lowest level since November 2008, and is likely to stay under pressure with the bond yields of vulnerable economies such as Spain and Italy still at elevated levels.
Investors have stepped up sales of the euro in favour of safer havens, disheartened by the lack of progress towards solving the bloc's debt crisis.
"There's certainly risk to the upside for sterling, especially with yesterday's news about a delay at the German Constitutional Court. That will certainly be a source of concern for the euro," said Richard Driver of Caxton FX.
Some participants had been expecting a quick court ruling on whether the euro zone's bailout fund, the European Stability Mechanism (ESM), and planned changes to the region's budget rules are compatible with German law, but the verdict now seems likely to take months.
German Finance Minister Wolfgang Schaeuble said any significant delay in approving the ESM, which requires German backing to come into effect, could lead to more market turmoil and undermine confidence in the euro zone.
Adding to the overall bearish mood towards the euro, Italian Prime Minister Mario Monti said on Tuesday his country could be interested in tapping the euro zone's rescue fund for bond support.
The euro's latest gains against the pound pushed sterling's trade-weighted index to a six-week high of 83.8, data from the Bank of England showed.
A sustained rise in the index could pose a challenge to British policymakers who are trying to rebalance the UK economy by encouraging exports, analysts said.
WARNINGS
The deepening crisis in the euro zone is a huge risk to the UK economy because the region is Britain's largest trading partner.
Bank of England governor Mervyn King on Tuesday warned the British economy was showing few signs of recovery and analysts predicted output would prove to have remained sluggish in June due to a double holiday.
Still, sterling was up nearly 0.3 percent against the dollar to $1.5554 on Wednesday. Analysts said lacklustre US corporate results weighed on the dollar for now.
"As with the euro, we may see sterling gains over the coming weeks with US corporate earnings expected to disappoint," said Craig Erlam, an analyst at Alpari, in a note to clients.
Shares in several US companies including engine maker Cummins, appliances and electronics chain Hhgregg and memory disk maker OCZ Technology Group fell in after-hours trade on Tuesday after they warned on larger-than-expected losses through the rest of the year.
Later on Wednesday the US Federal Reserve will publish minutes from its meeting last month, but Caxton FX's Driver said he did not expect them to be a "market mover."
"I think they will be watched, but don't think it will tell us much about QE3," he added, referring to more quantitative easing in the world's top economy.
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