Sterling rose from a two-week low against the dollar and recovered ground against the euro on Thursday, helped by gains in European stock markets, although worries about Britain's future in the European Union is likely to limit any advance. The pound was up 0.2 percent at $1.4315, up from Wednesday's $1.4235, its weakest level since February 1. Sterling tends to move in sync with riskier assets because of Britain's large current account deficit and relatively high interest rates compared with other developed economies.
The euro was flat at 77.85 pence with corporate demand lined up around 77.75 pence, traders said. The focus is on a two-day European summit starting on Thursday, where British Prime Minister David Cameron will try to secure more favourable terms for Britain's membership of the EU. Analysts say sterling could be knocked down sharply if Britons voted to leave in a referendum that could come as early as June. Goldman Sachs has said sterling might fall as much as 15 to 20 percent. Ratings agency Standard & Poor's has said Brexit could hurt the pound's role as a global reserve currency.
"Sterling may remain on the back foot as Cameron faces increasing pressure securing a deal over the EU summit," said Hans Redeker, global head of currency strategy at Morgan Stanley, adding that opposition to some of the proposals could scupper a deal. Reflecting the nervousness, the cost of hedging against swings in sterling's value over the next week was trading near its highest since Britain's general election last May, as investors brace for more volatility.
Analysts and traders are worried that the uncertainty could hit investments and the economy. Sterling has fallen around 6 percent against the dollar since mid-December as investors have pushed back bets on BoE rate rises to around 2020 and have moved to price in the chance of a cut in rates over the next year. "Irrespective of the twists and turns of the debate, uncertainty over the outcome is likely to weigh on UK markets for a good few months yet," global bond fund PIMCO said in a note. It assigns a 40 percent possibility of a "Brexit".
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