LONDON: Sterling rose against the dollar but fell against a buoyant euro on Monday as polls showing an increase in support for a pro-bailout party in Greece lifted riskier assets and triggered a short-covering rally in the euro.
With speculators' short positions in the euro hitting record high levels, analysts said the euro could see more gains in the short term, pulling it further away from a 3-1/2 year low against the pound.
However, most analysts expected it would soon resume its downward trend, with investors still highly concerned about the euro zone's problems, and in particular Spain's increasingly fragile banking sector.
Sterling was expected to continue to benefit as investors sought safer alternatives to the euro, despite recent data revealing Britain's own recession was deeper than previously thought while retail sales tumbled in April.
"We have seen a record level of euro shorts so it's no surprise that the slightest ray of hope that Greece may not leave the euro leads to short-covering that helps the euro," said Michael Derks, currency strategist at FXPro.
"But more generally sterling continues to attract decent capital inflows from Europe and Asia ... the bigger picture is that euro/sterling will go lower." He said the euro could drop to 75 pence by the end of the year.
The euro was up 0.4 percent at 80.21 pence.
However, it remained not far above a low of 79.80 pence hit 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.
Surveys showed Greece's conservatives have regained an opinion poll lead before elections on June 17. That raises the odds of a government agreeing to harsh bailout terms that may enable it to remain in the euro zone.
More appetite to take on risk lifted sterling 0.2 percent against the safe-haven dollar to $1.5695. However, it remained not far from a two-month low of $1.5630.
However, investors remained very wary, with Spanish borrowing costs rising following the state's takeover of Bankia due to worries about the amount Spain is having to pay to prop up its ailing banking sector.
The pound could also come under further pressure against the dollar if investors see a greater risk that a weak economy may prompt the Bank of England to extend its bond-buying programme.
BoE policymaker Spencer Dale was quoted in the Sunday Times saying uncertainty in the euro zone will continue for the next few years, acting as a drag on the UK economy.
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