FX COLUMN-Politics may leave sterling lagging euro

Mon Oct 22, 2012 1:04pm BST

-- Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own --

By Neal Kimberley

LONDON, Oct 22 (Reuters) - Good news on the British economy last week could not stop sterling falling against the euro.

Perhaps, with the euro zone crisis in abeyance, investors are less inclined to buy sterling as a bulwark against the risk of euro depreciation.

Alternatively, perhaps investors have been spooked by growing signs of political rifts between Britain and its European Union partners.

Either way, the euro could be set to head higher against the pound with 83 pence -- a level not seen since April -- a potential target.

Better British jobless figures, higher retail sales and improved public finance data all failed to give the pound a boost.

The single currency strengthened against sterling to a high of 81.47 pence at the end of the week from a low of 80.37 pence last Monday.

Tension over the euro zone crisis has diminished of late.

Spanish Prime Minister Mariano Rajoy secured backing for his austerity drive in his home region of Galicia on Sunday, removing a potential obstacle to him asking for a bailout. The euro rose broadly.

But Britain's relations with the European Union seem to be going through a periodic rocky patch.

Finland's Europe minister, Alex Stubb, told Reuters on Thursday that Britain's policy towards Europe was becoming harder to understand and that the United Kingdom may be slowly waving goodbye to the European Union.

British Prime Minister David Cameron, speaking on Friday, may have rejected this notion but he wants changes to the relationship between the UK and the EU.

The fact that Cameron has said he is prepared to use Britain's national veto to block any EU budget it deems unacceptable at a Nov. 22-23 summit will have ruffled feathers among other European leaders.

Yet having publicly gone down this route, it becomes more difficult for the him to row back.

The Oct. 10 collapse of the proposed merger between Britain's BAE and the European aerospace company EADS is likely to have left a sour taste in UK government mouths, with the deal stymied by Germany.

Asked whether he was interested in leaving the EU, which Britain joined in 1973, Cameron said "no", but the fact this subject is being raised may unnerve some investors.

For many, part of the allure of sterling is that Britain is in Europe but out of the euro zone. The prospect, however distant, of Britain being out and out is a different ball game.

With Cameron's performance as premier coming under increasing scrutiny even by members of his own party, some investors might not be surprised to see him taking a hard line in dealings with the EU.

But other European leaders might be tempted to push back.

Such uncertainty could leave the British pound on the back foot and the euro/sterling exchange rate heading up.

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