LONDON (Reuters) - Sterling rose on Thursday, hitting a two-year peak against the euro and a near two-week high against the dollar on growing expectations that Scotland will vote to stay within the United Kingdom.
Thursday's vote on whether Scotland will opt for independence or not closes at 10 p.m. (2100 GMT) and the first trends are likely to come out a few hours after that.
Most surveys show those supporting independence slightly behind those voting for a union, but given the high number of people who are still undecided, it was too close to call.
Sterling rose to $1.6388, well above a 10-month low of $1.6051 struck last week. It has bounced from those lows as investors trimmed bets against it after most polls in Scotland showed those in support of the union were ahead.
The pound also gained against the euro, which fell to 78.53 pence, its lowest since August 2012. The common currency was also hit after the European Central Bank handed out a below-forecast 82.6 billion euros in its first offering of four-year loans. Traders said the lower take-up would keep pressure on the ECB to opt for quantitative easing.
"It seems people are growing reasonably confident of a "No" vote in Scotland," said Ian Gunner, portfolio manager at Altana Hard Currency Fund.
"The risks are if it goes the other way, and that is one of the reason why overnight implied vols are still trading higher."
Financial investors stepped up hedging against sharp fluctuations in the value of Britain's pound over the next 24 hours. The overnight sterling/dollar implied volatility rose to a high of 34.75 percent, almost 10 times levels seen a month ago, having closed on Wednesday at around 12.75 percent. The overnight options will expire on Friday, when results for the Scotland vote will be announced.
Currency dealers said they are bracing for choppy trading as the first regions likely to report results could show a tendency to lean towards independence. That could put sterling under pressure.
Larger regions, with the highest percentage of the vote, are not expected to report until later, and the final result may not be clear until 0400-0500 GMT on Friday.
Sterling has lost 1.4 percent against the dollar this month, weighed by concern a Scottish vote for independence would undermine investment and growth and prompt the Bank of England to push back an expected rise in interest rates.
Traders said while there are few signs of panic amongst investors, there was a great degree of caution. A "Yes" vote could lead to significant weakness in the pound on the prospect of long-drawn-out negotiations over North Sea oil revenues, possible new trade barriers and, crucially, uncertainty about which currency the Scots would use.
This is likely to keep investors wary of British assets in the near term while lower growth expectations could prompt rating agencies to downgrade Britain's debt.
"There is an unsettling degree of uncertainty on the quality of the polls surrounding this event and that a "Yes" vote shock, while unlikely, is possible and could mean discontinuous moves in the market and volatility of several multiples of the norm," said John Hardy, head of currency strategy at Saxo Bank.
Until a turnaround in mid-July, sterling had been one of the best performers among major currencies in the past year, propelled by expectations robust economic growth would prompt the BoE to raise interest rates by early next year.
Data on Thursday showed retail sales volumes rose 0.4 percent on the month, in line with forecasts and the strongest growth since April, after flatlining in July. On the year, retail sales were up 3.9 percent last month, also a four-month high, but slightly lower than expected.
Attention, though, was on the Scottish vote with many currency traders likely to work through the night. Credit Suisse is keeping its specialist sterling traders overnight in their London office for the referendum.
Traders said in the case of a "No" vote, sterling could jump to $1.6750/1.68 against the dollar while the euro could drop to 77.50 pence.
Reporting by Anirban Nag; Editing by Catherine Evans, Ruth Pitchford and Crispian Balmer