LONDON Sterling rose on Monday, recouping some of last week's steep losses that sent it tumbling to a 15-month low against the euro, as market players booked profits on recent euro strength.
Weak Spanish data and political uncertainty in Spain and Italy also weighed on the euro. Analysts said this could help the pound make further gains against the euro in the coming weeks.
However, they said sterling remained vulnerable to UK economic worries, especially against the dollar.
The euro was down 0.8 percent at 86.27 pence. It retreated following sharp gains on Friday when it rose more than 1.5 percent to hit 87.17 pence and posted its biggest daily percentage rise since October 2009.
Traders reported central banks and hedge funds buying sterling. The euro looked poised to break below chart support at the 55-hour moving average around 86.24 and target 86.065 pence, a peak hit on January 30.
"Moving into February people are thinking euro/sterling is looking a bit rich and are taking profit," said Paul Robson, currency strategist at RBS, adding investors were nervous before a European Central Bank policy meeting on Thursday.
He said the euro could drop to 83 pence in the next couple of weeks and expected it to be at around 80 pence by mid-year.
Analysts at Nomura also recommended selling euro/sterling at 86.55 pence, with a target of 82.00 pence and a stop at 87.50.
The euro has recovered in 2013 as growing confidence in the euro zone prompted investors to buy it against those currencies considered a safe haven alternative during heightened euro break-up fears. This included sterling.
Despite Monday's losses, the euro was still up more than 6 percent against the pound since the start of the year.
The pound's trade-weighted index last stood at 80.3, having earlier matched the 14-month low it reached on Friday of 79.9, Bank of England data showed.
UK ECONOMY WORRIES
A purchasing managers' survey on Monday showed UK construction sector activity continued to slide last month, with the pace of contraction remaining at December's level when it hit its lowest since last June.
Traders said the data had little impact on the pound, with the focus on a broad drop in the euro.
It was up 0.2 percent against the dollar at $1.5718, holding above a 5-1/2 month trough of $1.5674 hit early last week.
"Cable (sterling/dollar) is still vulnerable to the downside simply because the UK economy is going nowhere and the U.S. economy is looking reasonable," said Michael Derks, chief strategist at FXPro, adding it could drop to $1.54 within the next 4-6 weeks.
Focus this week will be the PMI survey of the dominant services sector on Tuesday for clues on how the economy fared in early 2013 after contracting in the fourth quarter of 2012, and a Bank of England meeting on Thursday. The BoE is seen keeping interest rates and its quantitative easing target unchanged.
Morgan Stanley analysts recommended clients sell sterling at $1.5760, with a target of $1.5400 and a stop at $1.5900.
"The market is not positioned for a more dovish BoE, and we believe that there is room for investor to price in a larger probability of easing, even if this does not come to pass."
Testimony by BoE Governor-designate Mark Carney before a parliamentary committee later this week may also knock the pound if he hints he favours more monetary easing.
(Editing by Toby Chopra)