Sterling was steady on Tuesday, staying vulnerable against the dollar as worries about Spain's fragile banking sector kept investors nervous of taking on risk. It remained supported against the euro, not far from its recent 3-1/2 year high due to inflows from investors seeking safety from problems in the euro zone.
But gains could run out of steam if expectations grow that the Bank of England may have to ease monetary policy to support a floundering economy. The pound barely reacted to a survey unexpectedly showing British retail sales jumped in May, with last week's data showing the UK economy contracted more than previously estimated in the first quarter still weighing on sentiment.
"Sterling has done so well recently we're seeing some correction after its recent run ... The focus is elsewhere and the pound has run out of steam," said Lee McDarby, head of dealing for corporate and institutional treasury at Investec. Sterling was steady against the dollar at $1.5671. It was not far from a two-month low of $1.5630 though traders cited strong support around $1.5645, the 61.8 percent Fibonacci retracement from this year's lows to April's highs. "A break below this key level ($1.5645) should prompt a move back towards this year's lows around $1.5236," said Craig Erlam, market analyst at Alpari.
The euro stayed steady against the pound at 79.95 pence, with traders citing bids at 79.80 pence, the low hit on Friday. A break below there could leave it on course to retest a trough of 79.50 hit earlier this month, its lowest level since November 2008.
Investors were cautious, fretting in particular about Spain's increasingly fragile banking sector and a jump in Spanish borrowing costs. The pound would come under pressure against the dollar if investors see mounting risks to an already weak UK economy from the turmoil in the euro zone, which could prompt the Bank of England to extend its bond-buying programme.
That would be bearish for the currency as it increases the supply of pounds in the system and drives down short term rates. BoE chief economist Spencer Dale said in an interview broadcast on Tuesday that Britain's economy was still feeling the benefit of 325 billion pounds of quantitative easing already undertaken, adding that the economy is expected to grow this year while inflation is still above target.