Jessica Mortimer London

Sterling rose to its highest level in 19 months against the euro yesterday and was poised for more gains as concerns about budget problems in Spain caused Spanish borrowing costs to jump and prompted investors to seek alternatives to the common currency.

The pound also benefited after Standard & Poor’s (S&P) reaffirmed Britain’s top-notch AAA credit rating on Friday, reflecting an expectation that the government will continue to consolidate its public finances.

This encouraged investors to flock to sterling assets as Spanish 10-year government bond yields broke above 6 percent for the first time this year, sparking concerns about the prospect of a new bout of financial stress in the euro zone.

“Sterling has gained a modicum of support from the S&P comments, but it’s really all about euro zone bond yields,” said Richard Driver, an analyst at Caxton FX.

“If bond yields keep creeping up it will raise major concerns about the firewall (designed to prevent contagion from the euro zone debt crisis) and the euro will come under further pressure. We definitely see euro/sterling below 82p (R10.26)”.

The euro lost about 0.5 percent on the day to hit 82.1p, its weakest since September 2010, stopping just above reported options barriers at 82p.

Some analysts say Spanish 10-year borrowing costs above 6 percent would be unsustainable if maintained for an extended period. Italian bond yields also rose yesterday.

Sterling could be on track to test its August 2010 high of 81.79p to the euro and then the June 2010 peak of 80.67p. Many analysts believe it may break beyond the key 80p level for the first time since late 2008.

Sterling’s trade-weighted index stood at 82.2, near last week’s 19-month high of 82.4, according to Bank of England data. The pound’s rate against the euro makes up about 50 percent of that index.

The pound benefited as recent economic data hinted at signs of improvement in the UK while the euro zone economy stutters. However, the UK economy remains fragile and the pound could come under pressure if UK jobs data tomorrow are weak or if Bank of England minutes on the same day suggest further quantitative easing remains a possibility.

The pound’s gains could also be reined in if UK policymakers express concerns about the recent gains and the potential damage its strength might do to exports.

However, most analysts see this as unlikely for the time being as the pound has been gaining fairly gradually and it is still considered relatively weak on a long-term basis.

No major data was due for release yesterday.

Euro zone worries weighed broadly on riskier currencies against the safe-haven dollar, however, pushing sterling down 0.1 percent to $1.5826 and taking it close to the late March low of $1.5801.

“Sterling remains firm against the euro and solid against the dollar, but continued euro weakness should logically undermine sterling-dollar from here,” analysts at Lloyds said. – Reuters