LONDON (Reuters) - Sterling fell to a seven-month low against the dollar on Tuesday on growing speculation the UK could soon lose its prized triple-A credit rating, traders said.
The pound fell to $1.5426 (1.0002 pounds), off a session high of $1.5505 (1.0053 pounds) and its weakest level since mid-July. Traders cited stop loss buy orders above $1.5520 (1.006 pounds) with talk of inflows from a large UK based company helping the pound earlier in the day.
The euro rose against the pound to 86.58 pence, recouping earlier losses from 86.10 pence. Data showed the ZEW index of German economic sentiment rose to its highest level since April 2010, helping to support the single currency.
Barring a credit rating downgrade after European markets close, the focus will be on the minutes from the Bank of England's latest policy meeting, due on Wednesday. Investors will eye signs on whether policymakers will continue to tolerate above-target inflation and want the pound to weaken further.
The pound has lost considerable ground since the start of the year as concerns about a UK recession, prospects of more monetary easing despite stubbornly high inflation and the risk that credit rating agencies could downgrade Britain's debt as Chancellor George Osborne falls behind in his debt reduction targets have all combined to push it lower.
"(A downgrade rumour) probably gets mentioned a couple of days a week," said Geoff Kendrick, currency analyst at Nomura, adding the impact from such talk was muted, for now.
Most expect a ratings change after Osborne presents his budget in the latter half of March.
Far more important for the pound, Kendrick said, was the Bank of England's tolerance of higher inflation to support growth.
"Any more detail on that (the tolerance of inflation for longer and maintaining an easing bias) is probably currency negative," he added.
Sterling has shed nearly 5 percent against the dollar so far this year and its trade-weighted index hit a near 16-month low of 79.6. The euro has gained more than 6 percent against the pound this year, having risen to a 15-month high of 87.17 pence on February 1.
The pound looked likely to face renewed selling against the dollar if minutes from the U.S. Federal Reserve, to be released later on Wednesday, painted a contrasting picture of a stronger economy and hint at tighter policy in future.
"It feels like the sterling move we have seen has occurred very quickly and that could encourage some investors to take some profit, but it will only be a pause," said Valentin Marinov, head of European G10 currency strategy at Citi.
"Ahead of the BoE and Fed minutes tomorrow risks could be still on the downside, especially if we see evidence that the FOMC (Federal Open Market Committee) members discussed reducing the pace of its asset purchases if the U.S. recovery is sustained."
Comments from Bank of England policymaker Martin Weale, who said the currency may need to weaken further to rebalance Britain's economy, and a glum inflation report last week forecasting higher inflation and weaker growth have also hurt sterling in recent days.
The bank's policy committee as a whole had already signalled in minutes from its January meeting that the currency might be above the level needed to boost British exports.
Traders said reports of hedge funds selling the pound in anticipation of looser monetary policy under the next Bank of England governor, Canadian Mark Carney, added to the gloomy outlook for sterling.
Citi client flows showed hedge funds had gone aggressively short of sterling, but corporate investors had so far not participated much in the recent sell-off.
Additional reporting by Nia Williams; Editing by David Cowell, Ron Askew