Worries about whether Cyprus will approve a bailout plan pushed sterling to a five-week high against the euro on Tuesday, though caution before Wednesday's UK annual budget may limit its gains. The euro fell 0.7 percent to 85.055 pence, its lowest since February 11, as market players became increasingly nervous that the Cypriot parliament may reject a bailout package which includes a controversial levy on bank deposits.
Gains against the euro lifted the pound's trade-weighted index to a four-week peak of 79.7. "Markets are being dominated by events in Europe at the moment but there are some big events coming up in the UK with the BoE minutes and the budget," said Saeed Amen, currency strategist at Nomura. Investors were wary that UK finance minister George Osborne could announce a change in the Bank of England's (BoE) remit to allow more leeway on inflation targeting, paving the way for further monetary easing.
The minutes to the BoE's policy decision earlier this month will also be closely watched on Wednesday for any signs that policymakers are inclined towards opting for more asset purchases under its quantitative easing programme. "We expect the minutes to show a similar breakdown to last month and believe sterling could see a short-term squeeze (higher), although this is not likely to be long-lasting," Nomura's Amen said, adding that weak economic data would continue to weigh on the pound.
Quantitative easing effectively means printing money and is usually negative for a currency as it increases the supply. Last month's BoE minutes showed three out of nine policymakers, including Governor Mervyn King, voted for more QE. Against the dollar, sterling was up 0.1 percent at $1.5115, though it stayed well below a peak of $1.5177 reached on Friday, with traders reporting offers around that level. Options markets showed investors betting increasingly on more sterling weakness, with traders reporting demand from hedge funds to buy bets on a drop to $1.45 in three months.
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