LONDON - Sterling fell against the euro on Wednesday as safe-haven flows exiting the euro zone and into UK assets eased, with investors preferring the US dollar as nerves set in ahead of the election in Greece over the weekend.
The euro edged up 0.3 per cent against the pound to 81.15 pence (S$1.6.) It recovered from a two-week low of 80.11 pence hit on Tuesday when investors sought alternatives to the euro as Spanish bond yields rose.
The common currency has been stuck in a range roughly between 81.50 pence and a 3-1/2 year low of 79.50 pence since the start of May, and analysts said it was likely to remain trapped within a tight range before the Greek vote.
But sterling could gain against the euro, if the Greek elections at the weekend injected more uncertainty in the coming weeks.
And while sterling will benefit against the euro if the situation in the euro zone deteriorates, the pound would be sold off against the dollar on mounting concerns that the UK economy will be hurt by the turmoil in the country's biggest trading partner.
As such, sterling could be set for further declines against the dollar due to concerns that the Bank of England will opt to ease credit conditions in the economy in order to counter the effects of the euro zone debt crisis.
"If there's another inconclusive result (in Greece), then there could be concern that a further meltdown in Europe might tip the Bank of England's hand from (a quantitative easing) point of view," said Michael Hewson, senior market analyst at CMC Markets.
Sterling was 0.1 per cent lower against the dollar at US$1.5493 (S$1.9815) with bids cited at US$1.5470 and US$1.5450 with offers around US$1.5500. Traders also cited resistance at US$1.5601, the high struck on June 7.
Morgan Stanley said in a note it was bearish on the British pound against the dollar, given the UK's significant trade and banking links into the eurozone.
"Moreover, rising lending rates despite low policy rates suggest the Bank of England (BoE) may need to do more to stimulate the economy," their currency strategists said in a note.
Following a string of recent weak UK data, a growing number of analysts think the BoE could opt for another bout of asset purchases under its quantitative easing (QE) programme, possibly as early as next month.
More QE is usually considered bearish for the currency as it increases the supply of pounds in the system.
Bank of England Governor Mervyn King will deliver a speech later in the day. Speculation has been rising King will announce measures to increase liquidity to the banking system after BoE Deputy Governor Paul Tucker said earlier this week the central bank should consider steps to alleviate tight credit conditions.