The relative moves of the sterling curve versus that of euro rates are known as a "box" and market players trade by placing a flattening position on one curve versus a steepening position on the other.

The box -- based on the euro zone 2/10 year interest rate swap curve versus the UK equivalent -- is at its highest levels since 1993 at just above 100 basis points, according to Reuters data, against a backdrop of sluggish UK economic growth and an inflation-fighting ECB.

While the ECB is fully expected to hike interest rates 25 bps on Thursday to 0.75 percent, the BoE is not seen budging until at least May next year and a hawkish tone from ECB President Trichet could see the box extend its move.

"This is being driven by the euro curve and the more (the ECB) hike rates, the more the curve should flatten," said Lloyds Bank strategist Charles Diebel.

"In the short-term this (box) can run further, with the UK data proving soft there's nothing to stop it. But if the euro zone is doing so well, the bleak outlook for the UK is ultimately misplaced."

Diebel said that the euro zone curve could flatten to around 100 basis points from its current 135 basis points, although not all of that would feed through to the box as such a flattening would pull on the shape of the UK curve.

GREEK WORRIES SEND QUARTER END REPO VOLUMES TO NEAR RECORD

Overnight secured lending over the half-year turn last week against the backdrop of Greek parliamentary votes on new austerity measures pushed average repo -- or unsecured lending volumes -- up to new highs.

Average volumes over a 20-day period hit 220 billion euros, topping levels seen before the financial crisis hit in 2007, Broker ICAP said.

But the pervading risk-off attitude in markets meant that term-lending remained very thin.

ICAP said some sections of the market had to pay up aggressively to secure funds, but there was no sense of panic.

For example, overnight German general collateral averaged around 1.1 percent, with the Spanish equivalent averaging around 2 percent but with trades as high as 2.5 percent.

Overnight unsecured funds saw bids as high as 2.75 percent from peripheral banks, but with an average around 1.7-1.8 percent, the broker said.

"The high volume in euro lending secured against government bonds can be viewed in the long-term context, initially of the market's recovery from the sub-prime crisis, and latterly the peripheral debt crisis," said ICAP strategist Christopher Clark.

The preference for secured lending has also been seen with the introduction in the UK last month of the Repurchase Overnight Index Average Rate (RONIA) , the weighted average rate of all secured sterling overnight cash transactions.

Average volumes in June came to 10.5 billion euros, compared with 10.3 billion for the long established SONIA unsecured overnight lending market, according to Reuters data.

The Wholesale Market Brokers' Association says such secured transactions now account for over 40 percent of the overnight lending market in the UK.

Copyright Reuters, 2011