LONDON (Reuters) - Sterling has room for further gains, particularly against the euro, technical charts show, as it benefits from broad weakness in the single currency due to concerns over Greek fiscal health.
Any rise, particularly against the dollar, is likely to be limited, however, given the raft of reasons to be bearish on sterling, including concerns over the UK's ballooning deficit, political uncertainty before an election, and a weak economy.
The euro has fallen to a four-month low close to 88 pence, below its 200 day moving average -- currently around 88.66 pence, according to Reuters charts -- and below its two-year trend line support. These are bearish signals for euro/sterling.
"It is symptomatic of the problems in the euro zone that sterling is performing better," said Michael Hewson at CMC Markets.
"The break of the trend line from the October 2008 lows does not bode well for the euro and the break below two-month lows at 88.30 is a particularly bearish development," Hewson said, adding a close below there could send the euro down to levels last seen in September 2009 around 87.05 pence.
Similarly there are some bullish signals for sterling/dollar, which has jumped well above its 200-day moving average around $1.6148 to gain momentum above $1.63 and breach trend line resistance from the November highs at $1.6879.
"Everyone has been very cautious about UK PLC for a long time. They saw the UK as one of the countries that was most vulnerable and it was a very, very one-way vision," Mizuho technical analyst Nicole Elliott said.
"But I feel the pound was oversold last year and see euro/sterling grinding slowly, at a glacial pace, down to 84 pence within six months," she said.
Elliott also sees sterling/dollar's recent rise as a "corrective" bounce that could go further rather than an unsustainable "topping" move. She reckons the pair can move to $1.77. This week's price action in sterling has supported her view, she said.
The euro's sharp fall on Friday undermined expectations of further euro strengthening held previously by several technical analysts.
Fabien Manac'h, a technical analyst at Societe Generale, said a sustained break below 88.20 pence would put his mid-term bullish view at risk and pave the way for a move down towards 87.05 pence.
For now, however, Societe Generale still expects the 88.20 pence support level, or the tentative long-term rising support line which comes at 87.30 pence this week, will "force euro/sterling to enter another lasting recovery."
Sterling could come under pressure next week, which will see a slew of key UK data -- including inflation and public finance numbers -- as well as Bank of England policy meeting minutes, although any move on these factors is not expected to change the medium to longer-term technical outlook.
A further risk could come in February, when the BoE is expected to say whether it plans to pause in its asset purchasing plan.
Sterling's latest gains reflect negative sentiment towards the euro due to heightened worries over a dire fiscal situation in Greece and, potentially, in other euro zone countries, rather than to positive sentiment towards the pound.
Many believe this means any scope for sterling to gain against the dollar will be limited, particularly as a raft of negative factors hang over it.
"Sterling could go to $1.6450 against the dollar, helped by a very weak euro, but upside will be capped. It hasn't made much in the way of strong gains against the dollar and momentum is tapering off slightly," CMC's Hewson said.
Karen Jones at Commerzbank said the 2009 high around $1.7050 was a "critical level" for sterling/dollar.
"Sterling has topped in the bigger picture and while cable is below $1.7050, I'm not going to change that view," she said.
One of the biggest risks is that a UK general election, due by June, will result in a hung parliament, where no party has an overall majority, making it difficult to enact some of the potentially harsh fiscal measures needed to bring down UK debt.
"A lack of clarity on how UK political parties will tackle the deficit will weigh on markets as they hate uncertainty," CMC's Hewson said.
Reporting by Jessica Mortimer and Neal Armstrong, editing by Nigel Stephenson