LONDON Sterling hit a near three-week high against the euro on Monday, with the shared currency coming under pressure as investors fretted over the Italian prime minister's decision to resign.
Italian Prime Minister Mario Monti said on Saturday he would resign after the 2013 budget is approved, increasing political uncertainty in the heavily indebted country and dragging on the euro.
The euro dropped 0.2 percent against the pound to 80.37 pence. It hit a low of 80.35 pence in thin Asian trade, its lowest level since November 21, according to Reuters data.
Further weakness could see the euro test the November 8 low of 79.605 pence.
"The resignation offer of PM Monti in Italy is likely to weigh upon the euro going forward both against the pound and against the dollar," said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi.
"The risk of euro/sterling breaking below 80 pence has increased following the announcement, it could lead to a pick-up in safe-haven flows into the UK as we move into next year."
Concerns about the euro zone has helped support the pound this year as some investors seeking to cut exposure to the debt crisis bought sterling assets, viewing the UK as a relative safe haven.
Against the dollar, sterling gained 0.3 percent on the day to $1.6086 (1.0000 pounds), helped by a recovery in the euro against the dollar later in the session.
Market players said sterling was boosted by demand from longer-term investors, though gains could be checked by reported sell offers between $1.6080 (1.000 pounds) and $1.61.
The pound has fallen against the dollar in recent sessions, with the greenback lifted by faster-than-expected U.S. employment growth that prompted bets the Federal Reserve could opt for a smaller stimulus programme when it meets this week.
"Sterling is taking no independent direction, but the FOMC (Federal Open Market Committee) meeting is likely to announce some further asset purchases, in addition the market will be watching discussions on the fiscal cliff," said Michael Derks, chief strategist at FxPro, adding that a resolution to U.S. fiscal problems would boost the dollar and drag the pound lower.
The so-called fiscal cliff, a combination of automatic tax rises and spending cuts due to kick-in at the beginning of 2013, threatens to mire the U.S. economy in recession if an agreement is not reached before the year end.
The pound could benefit from safe haven flows out of the euro as market players fret over political uncertainty in peripheral countries amid speculation the European Central Bank could be considering a future rate cut.
Data on Monday showed Germany's trade surplus was its narrowest in more than six months in October after falling demand from its recession-hit European trade partners hurt its exports, also weighing on the euro.
Lower euro zone growth could fan demand for the pound, although the UK's economic outlook was also clouded after finance minister George Osborne lowered growth forecasts in his mid-year budget statement last week. That raised concerns rating agencies could soon cut the UK's prized AAA credit status.
Nomura analysts said immediate concerns about the UK have abated however, providing an opportunity to sell the euro against sterling. FX strategists said they sold euro/sterling at 80.50 pence, targeting 78.00 pence, with a stop loss order at 81.70 pence.
(Editing by Toby Chopra)