LONDON: Sterling inched up against the dollar and the euro on Tuesday as risk appetite showed some signs of improvement and on inflows from investors seeking safety from the euro zone turmoil.
But gains could run out of steam as expectations grow that the Bank of England may have to ease monetary policy to support a floundering economy.
The euro eased marginally to 79.89 pence, with traders citing bids at 79.80 and topside stops around 80.60 pence. The euro hit a low of 79.80 pence on Friday and a break below there could leave it on course to retest a trough of 79.50 hit earlier this month, its lowest level since November 2008.
Against the dollar, sterling was 0.2 percent higher at $1.5710, but not far from a two-month low of $1.5630. Traders cited strong support around $1.5645, the 61.8 percent Fibonacci retracement from this year's lows to April's highs.
Traders said some investors were cutting bullish bets in the safe-haven dollar and booking profits, helping currencies like the British pound.
"A break below this key level should prompt a move back towards this year's lows around $1.5236," said Craig Erlam, market analyst at Alpari.
"A lot of the dollar strength has come from its safe haven status throughout the euro zone debt crisis. So a positive Greek election (next month) could result in a move back above $1.60."
Currencies perceived to be riskier like the Australian and New Zealand dollars and to some extent sterling got a lift on Monday as polls showed an increase in support for a pro-bailout party in Greece. But investors are cautious, fretting in particular about Spain's increasingly fragile banking sector and a jump in Spanish borrowing costs.
The pound would come under pressure against the dollar if investors see mounting risks to an already weak UK economy from the turmoil in the euro zone, which could prompt the Bank of England to extend its bond-buying programme.
That would be bearish for the currency as it increases the supply of pounds in the system and drives down short term rates.
Bank of England chief economist Spencer Dale said in an interview broadcast on Tuesday that Britain's economy was still feeling the benefit of 325 billion pounds of quantitative easing already undertaken, adding that the economy is expected to grow this year while inflation is still above target.
His comments lent some support to sterling, but with recent data showing more signs of slowing activity, the BoE may have to consider another round of QE in the near term, traders said.
"UK domestic economic data have continued to deteriorate, and today's CBI sales report for May is expected by the consensus to show renewed deterioration. We have tightened the stop on our short position to protect profits," Morgan Stanley strategists said in a note.
"While we remain bearish sterling over the medium term, some relative safe haven support is still evident," Morgan Stanley strategists said in a note.
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