November 9, 2011 / 4:37 PM / 9 years ago

Sterling rallies vs euro after Italy bond yields jump

* Sterling hits 8-mth high vs euro as Italy debt worries mount

* TWI GBP also hits 8-mth high, but pound falls sharply vs firmer dlr

* Concerns about euro zone crisis impacting UK may pressure GBP

By Jessica Mortimer

LONDON, Nov 9 (Reuters) - Sterling rose to an eight-month high against a broadly weak euro on Wednesday after benchmark Italian bond yields rose to levels widely deemed unsustainable, taking the euro debt crisis to new levels.

However, the pound fell against the dollar, dragged down as investors sought the safety of the U.S. currency and by worries that the crisis in Britain’s euro zone trading partners could push the UK economy back into recession.

The euro fell roughly 1 percent on the day to 85.09 pence, its lowest since early March, after the 10-year Italian government bond yield jumped above 7 percent.

Traders said demand to sell euros for sterling from a UK firm related to dividend payments also pushed the shared currency lower.

Market participants said the pound could gain further versus the euro if Italian bond yields keep rising. Sterling’s trade-weighted index rose to an eight-month high of 80.9 .

“The sovereign debt crisis in the euro zone is really driving everything, with everyone keeping an eye on Italian bonds,” said Andre de Klerk, head of options and advisory at Moneycorp.

“The UK isn’t part of the euro and it has a bit of fiscal and monetary manoeuvrability but the euro zone is our biggest trading partner and this crisis will affect the UK significantly.”

Some analysts said any sign of weakness among UK financial institutions due to their exposure to debt issued by weak euro zone nations would knock the pound, as it would highlight the UK’s vulnerability to the debt crisis.

But for now, they said the single currency was bound for more weakness against the pound.

“A close in euro/dollar below $1.36 will add to downward momentum in euro/sterling,” said Sebastien Galy, currency strategist at Societe Generale.

On Wednesday, the euro hit a one-month low of $1.3552 , breaking below its $1.36-1.38 range seen so far this month.

Galy added that he saw the possibility of a fall towards 83.00 pence, which would be around the lowest of the year.

Sterling fell more than 1 percent on the day to $1.5911, before pulling back to $1.5947 in late London trade.

“Sterling is just caught in the crossfire of what’s going on in the euro zone,” said Adam Cole, currency strategist at RBC, adding this will mean it weakens against the dollar even as it gains versus the euro.

Also weighing on sentiment towards the pound, data on Wednesday showed Britain’s trade deficit deteriorated much more than expected in September to 9.814 billion pounds, its widest since the series began in 1998.

The Confederation of British Industry said the risk of another recession had risen as it cut its forecasts for UK economic growth, although it believed Britain could avoid this.

Consistent weakness in the UK economy prompted the Bank of England to adopt further quantitative easing last month, which is often considered currency negative as it involves flooding the market with pounds. Despite this, sterling has held up against a broadly weak euro. (Additional reporting by Naomi Tajitsu; Editing by Ruth Pitchford)

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