Sterling crept up versus the euro on Tuesday as investors sold the shared currency on uncertainty over whether Italy will be able to pass a crucial vote on public finances later in the day, with Prime Minister Silvio Berlusconi under pressure to resign.
The pound hovered near a one-month high versus the euro, helping it to remain at its strongest level against a currency basket since March.
Sterling is considered a safer bet than the euro because Britain's government is perceived to be more in control of implementing austerity measures to improve its public finances, something that euro zone countries including Italy and Greece have struggled to do so far.
This has kept UK debt yields much lower than those in Italy and Greece, keeping their appeal high among investors looking for relatively low-risk assets and supporting the pound.
Italy's parliament is due to debate and vote on fiscal reforms beginning at 1430 GMT. Failure to pass the reforms could sink Berlusconi's government.
Analysts say his resignation could offer some short-term relief to the euro, which has been stung by the view Italy needs new leadership to survive its debt crisis.
"If the Italian vote fails, and Berlusconi loses a confidence vote, we could see a short-term fillip for the euro, which would be negative for sterling but I think that would be transitory," said Simon Smith, economist at FXPro.
"Sterling has certainly gained some benefit on what's been going on in Italy, and that's likely to continue the modest sterling appreciation versus the euro," said Simon Smith, economist at FXPro.
The euro slipped 0.2 percent to a session low of 85.57 pence, closing in on 85.48 pence hit last week, its weakest since early October.
Further euro downside was limited by bids seen around 85.50, and technical support around 85.48, now its 200-week moving average.
On a trade-weighted basis , sterling stood 80.8, holding at an eight-month high first hit on Monday.
The pound inched up 0.2 percent on the day to $1.6080, supported by bids seen below $1.6040. Its upside was capped by offers seen ahead of $1.6100, according to traders.
Ten-year UK gilt yields hovered around 2.29 percent , way below the 6.65 percent for the same maturity for Italian debt , near a euro zone lifetime high which is widely considered unsustainable.
Many in the market believe widening yield spreads between UK gilts and the debt of some euro zone countries will continue to boost the pound, although analysts caution that further, significant gains may be limited due to ongoing signs of weakness in the UK economy.
Data showed UK industrial output was at a standstill in September, weaker than forecasts for a 0.1 percent rise, although the year-on-year reading was slightly stronger than expected. Manufacturing output rose more than forecast.
But a weak reading of UK retail sales on Tuesday suggested that sluggish consumption may continue to hamper overall growth, with BRC retail sales falling 0.6 percent year-on-year in October.
Consistent weakness in the UK economy prompted the Bank of England to add to its asset-buying programme last month, but sterling has inched up against the euro despite the increased quantitative easing, which is often considered currency negative as it involves flooding the market with pounds.
"The dominance of the euro area peripheral tail risk has outweighed the negative impact of quantitative easing for the GBP." Credit Suisse analysts said in a note.
"The shortage of AAA reserve currency alternatives to the EUR implies that the GBP may continue to see demand from reserve managers despite QE."
But they added that sterling may suffer from any relief rally in the euro if euro zone officials are seen making headway on solving the debt crisis, given current strong market positioning for a weaker euro and growing downside euro risks in the options market.
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