LONDON Sterling hit a fresh 3-1/2 peak against the euro on Wednesday as investors, concerned about the lack of progress on efforts to solve the euro zone debt crisis, continued to seek the safety of UK assets.
The euro fell to 78.71 pence, its weakest since November 2008 and some expected it to drop to 77 pence in the near term, saying the single currency is likely to stay under pressure after the European Central Bank cut the deposit rate to zero last week.
The euro was last trading at 78.735, down 0.3 percent on the day. Traders cited selling of euros by corporates that saw the currency drop past a reported option barrier at 78.90 pence.
"The UK is a relatively safe place compared to Europe, and we're genuinely starting to see outflows from the euro zone and some of that is coming into the UK," said Geoff Kendrick, currency strategist at Nomura.
"We've cracked a key level at 79.50 pence, so we could go to 77 pence in the next couple of weeks."
Investors have stepped up sales of the euro in favour of safer-haven currencies and even higher-yielding currencies like the Australian dollar and the Swedish crown, as they are discouraged by the lack of progress towards solving the euro zone debt crisis.
Spanish bond yields eased on Wednesday as Madrid yielded to EU pressure and unveiled new measures designed to slash 65 billion euros from its deficit by 2014.
But overall the sentiment towards the euro remained bearish as political and legal hurdles on how to use the euro zone's rescue fund and the threat of contagion ensnaring larger economies in the currency bloc remained high.
RISK TO UK EXPORTERS
The pound's latest gains against the euro pushed sterling's trade-weighted index to 84, the highest level seen since May 17, data from the Bank of England showed.
A sustained rise in the index could pose a challenge to British policymakers, who are trying to rebalance the UK economy by encouraging exports, analysts said.
The Bank of England's Adam Posen was quoted on Wednesday as saying that Britain's economy was not as dire as some feared as private-sector job growth and exports painted a brighter picture.
Some analysts said the pound could consolidate at current levels against the euro in the aftermath of a 1.8 percent rise over the past five sessions.
"It's been a fairly quick move lower so maybe we will get stuck here for a while, but the medium-term direction is definitely down because there's zero chance of Europe being solved, at least this calendar year," Nomura's Kendrick said.
Technical indicators showed that the euro is approaching oversold levels against sterling.
The pair's Relative Strength Index, a measure of one currency's momentum versus the other, neared a key value of 30, a level not crossed to the downside since early May.
Against the dollar, analysts said the pound could rise further if U.S. corporate earnings continue to disappoint. The pound was last up 0.3 percent at $1.5562.
Several U.S. firms have warned this week of lower profits through the rest of 2012, and analysts said more profit warnings are expected as the earnings season continues.
Later on Wednesday the U.S. Federal Reserve will publish minutes from its meeting last month, but some currency analysts in London said they did not expect the minutes to shed any light on whether further asset buying by the Fed was likely in coming months.
(Editing by Susan Fenton)