THE pound hit its highest level against the euro for three-and-a-half years yesterday, as traders fretted over the outlook for Spain and Italy amid the single currency zone debt crisis.
Sterling also rose against the dollar, which was weighed down by news of a third straight monthly fall in US retail sales in June.
John Higgins, senior markets economist at Capital Economics, said: "The last time US retail sales fell for three months on the trot was late 2008. And we know what happened then.
"The markets took the bad news as a sign that the (US) economy could be heading for another recession. The dollar gave up some of its recent safe-haven gains, US stock prices declined, and the 10-year Treasury yield fell close to its June 1 record low of around 1.44% amid heightened expectations of further monetary stimulus."
However, while citing the "impending fiscal cliff" in the US, Mr Higgins added: "As it happens, we think the US economic recovery is unlikely to judder to a halt in the coming months."
Citing "reasons for guarded optimism", he said: "The direct trade and financial markets linkages between the US and the eurozone are not that great, the fall in commodity prices should boost real incomes, the housing market has started to recover, and US policymakers will probably reach a compromise on fiscal policy after the elections in November. "
The euro fell as far as 78.29p. It closed in London at 78.46p – down about 0.2p on its pre-weekend close.
Sterling's strength against the single currency is good news for tourists from Scotland visiting the eurozone. The pound closed at $1.5635 – up 0.85 cents on its Friday finish.
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