LONDON: Sterling rose to a 3-1/2 year high against the euro on Tuesday on worries about political instability in Greece, though investors were also wary of downbeat forecasts in the Bank of England's pending inflation report, checking its gains.
Investors have been piling to sterling as the euro crisis has stepped up a gear.
"People aren't buying sterling because they think UK growth is great. They're buying sterling because it's not the euro," said Adrian Schmidt, currency strategist at Lloyds.
Analysts said the pound's ascent could be halted temporarily if the central bank reacts to the recession in the UK economy by cutting its gross domestic product forecasts and hinting at the possibility of more easing.
But this was not expected to prevent sterling from pushing higher in the coming weeks as market players continue to buy the UK currency as a safer alternative to the euro.
The latter hit a low of 79.60 pence, its weakest level since November 2008, as Greece said it would hold a second round of elections in June after talks on forming a coalition broke down.
However, the pound dropped to a three-week low against the dollar of $1.6019, with investors wary of buying the currency ahead of the BoE report.
"We would not be at all surprised if we have a downgrade in growth forecasts (in the report) so that should lend to a softer sterling," said Lauren Rosborough, senior currency strategist at SocGen.
The report, due at 0930 GMT on Wednesday, is expected to show a tricky mix of lower growth and higher inflation and may also point to risks that the recent rise in sterling will dampen exports.
However, Lloyds' Schmidt said it would be difficult for the BoE to indicate they will do more asset-buying quantitative easing in the future when they opted just last week to put an end to money-printing via further asset purchases.
Sterling could be buoyed higher if the BoE instead highlights the fact that inflation has been too high rather than the risks to growth and suggests there will be no more QE.
"The danger on the inflation report is that the market
expects too downbeat a stance and sterling may go up on it."
EURO CONCERNS
Even if the pound comes under pressure after the inflation report, most expect it to be short-lived, with euro concerns likely to push the euro further towards the late 2008 trough of 76.93 pence.
Analysts expected the euro to slide further due to the political crisis in Greece, which could see its bailout plan scrapped and the country forced to leave the euro zone.
Adding to that, concerns remained about deep debt and economic problems in Spain, while Moody's cut ratings on 26 Italian banks on Monday, heightening worries the Greek debt crisis could scar peripheral euro zone economies.
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