LONDON: Sterling backed away from multi-month highs on Tuesday in holiday-affected trade after a weaker-than-forecast manufacturing survey highlighted UK economic fragility and the risk that a stronger currency may dent exports.
Its losses were limited, however, with the pound still seen as a popular alternative to an ailing euro, with some analysts believing UK first quarter gross domestic product data may be revised up after last week's unexpected contraction.
The purchasing managers' index on manufacturing dropped to 50.5 in April from 51.9 in March, the lowest since December and well below forecasts for 51.5. But it remained above the 50 level that separates growth from contraction.
UK new export orders posted their steepest fall since May 2009, suggesting recent gains in sterling - which hit a 32-month trade-weighted high on Monday - could be starting to hurt trade.
The euro hit a high of 81.985 pence, its strongest in nearly a week and well clear of a 22-month low of 81.23 pence hit on Monday, though volumes were low with most European markets closed for the May Day holiday.
The common currency was last up 0.3 percent at 81.80 pence, with traders saying hefty offers above 82 pence capped its gains, keeping it below an April 25 peak of 82.22.
"We saw some spike in euro/sterling after the worse-than-expected PMI, but it is still above the magic 50 number and marks some kind of return to normality after a strong reading in March," said John Hydeskov, chief analyst at Danske Bank.
Sterling's trade-weighted index dropped to 83.1, off Monday's high of 83.6, its strongest since August 2009.
Hydeskov said the euro's rise was unlikely to last, given growing concerns about debt problems in Spain and political uncertainty in France ahead of presidential elections this weekend. Danske forecasts euro/sterling to fall to 81 in three months, with a risk of it testing 80 pence.
Sterling's next target against the euro is the June 2010 high of 80.67 pence. Beyond there would take it to levels not seen since the aftermath of Lehman Brothers' collapse in autumn 2008.
Against the dollar, the pound was down 0.15 percent at $1.6206, below an eight-month peak of $1.6304 hit on Monday.
FRAGILE ECONOMY
Sterling has performed well since April's Bank of England policy minutes dampened speculation of increases in the bank's 325 billion pound asset purchase programme.
With its high levels of debt and strong trade links to a troubled euro zone, however, the UK economy remains fragile and more monetary easing remains a possibility.
Exports may also be hit further in the coming months as the euro zone economy weakens, especially if the pound continues to rise, posing risks to the British government's aim to rebalance the economy away from dependence on domestic demand.
Analysts said the equivalent PMI survey on the more dominant services sector on Thursday could have a bigger impact on sterling if it came in on the weak side.
There is also a risk that speculators may get overly upbeat about the pound's prospects, leaving room for a pullback. The latest IMM positioning data showed speculators flipped to a small long position in the week to April 24.
"Positioning data shows investors went long of sterling for the first time since August and there is scope for a bit of unwinding of those positions," said Jeremy Stretch, currency strategist at CIBC.
"North of $1.63 sterling looks toppish. While it is in a $1.50-$1.60 range it looks pretty fairly valued".
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