Sterling gains as euro zone weakness prevails

Fri Dec 7, 2012 9:38pm IST

* Euro falls after Bundesbank downgrades growth outlook

* Sterling weaker against dollar after strong U.S. jobs data

* Pound vulnerable to concerns about UK credit rating

By Philip Baillie

LONDON, Dec 7 (Reuters) - Sterling hit a two-week high against the euro on Friday after the German central bank cut the country's growth forecast and speculation of a future European Central Bank rate cut increased.

The pound fell against a broadly stronger dollar however, with the greenback helped by faster-than-expected U.S. employment growth prompted bets that the Federal Reserve could opt for a smaller stimulus programme next week.

Sterling showed little reaction to data showing UK factory output in October posted its biggest drop since June, although the numbers reinforced concerns the economy will shrink again in the final quarter of 2012 having just exited recession.

"For euro/sterling we have had more of a euro move in reaction to the ECB meeting on Thursday but sterling has been quite resilient in terms of UK data even though production was worse than expected," said Saeed Amen, FX strategist at Nomura.

The euro fell 0.2 percent to 80.59 pence, having earlier hit a low of 80.45 pence, its lowest level since Nov. 22. Market players reported bids at 80.30 pence that could cap further losses.

The shared currency weakened broadly after the Bundesbank cut German growth forecasts.

The report came a day after the European Central Bank predicted the euro zone economy would likely shrink next year, leaving the door open for future interest rate cuts and sending the euro broadly lower.

Comments from ECB Governing Council member Jozef Makuch saying the ECB may cut interest rates next year if the euro zone economy does not improve put the euro under further pressure.

But strategists said sterling strength against the euro could be short-lived if worries about the health of the UK economy mount.

"Generally speaking we are quite bullish euro/sterling given the weak (economic) fundamentals for the pound," said George Saravelos, FX strategist at Deutsche Bank.

UK OUTLOOK CLOUDED

Sterling fell 0.2 percent to $1.6020 retreating from a one-month high of $1.6131 hit on Tuesday.

Investors are wary of buying sterling after UK finance minister George Osborne said this week Britain would miss debt-reduction targets, raising concerns the country could lose its prized AAA credit rating.

"Fourth quarter growth is going to be very weak in the UK and Chancellor Osborne's statement did not put a bright shine on things. Following that we have got a heavy probability of a UK (rating) downgrade and that's not going to be good for sterling," Peter Kinsella, FX strategist at Commerzbank.

Disappointing UK data could reignite the argument for more monetary easing from the Bank of England, although policymakers opted to hold fire at their meeting on Thursday.

In contrast, some markets players scaled back expectations of easing from the U.S. Federal Reserve when it meets next week after non-farm payroll data showed an increase of 146,000 jobs, boosting the dollar.

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