Sterling rose to a 3-1/2 years high against a broadly lower euro on Friday after Moody's downgraded Italy and investors sold Europe's common currency in favour of perceived safer alternatives.
The euro fell as low as 78.63 pence against the pound, its weakest since November 2008. It was last at 78.74 pence, down 0.4 percent on the day. "The price action suggests this isn't a sterling move but rather a broader euro move," said Adam Myers, senior FX strategist at Credit Agricole.
Market participants continue to shun the euro due to the currency bloc's unresolved debt crisis and slowing global growth. Moody's cut Italy's credit rating by two notches to Baa2 late on Thursday and warned that further cuts could be on the cards if Italy's access to debt markets dried up. But the country passed a key market test hours after the downgrade, selling the planned amount in bonds at an auction on Friday that pushed the country's three-year borrowing costs well below 5 percent.
Sterling rose against the dollar as firmer equity markets encouraged investors to buy riskier currencies. Sterling was up 0.8 percent to $1.5541 against the dollar, nearing a high of $1.5578 hit earlier this week.
But analysts said sterling would be vulnerable against the dollar if worries grow about the euro zone or the global growth outlook, making investors more averse to taking on risk. "If the euro falls, we think cable (sterling/dollar) goes down with it," Myers said.
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