Sterling hit a seven-week low against the dollar on Friday, dragged lower by a weakness in the euro versus the U.S. currency on worries that European officials were making little headway in solving the euro zone debt crisis.
The pound fell to $1.5447, its weakest since early October, as investors sold currencies perceived to be risky for the safety of the highly liquid dollar, boosting it broadly.
The UK currency also struggled in the aftermath of bleak economic outlooks given by Bank of England officials on Thursday, and is poised to post its worst weekly performance versus the dollar in a year.
Market participants suspect asset managers have been shifting away from AAA-rated euro zone bonds -- including those from Germany, the region's strongest economy -- into UK gilts on the view that UK assets may prove a safe haven as the euro zone debt situation deteriorates.
Euro zone debt problems, along with surprisingly weak demand at a German bond auction this week, have prodded secondary market interest rates on Germany's bonds higher, putting them at roughly the same level as gilts. Historically, Bund yields have been lower than gilts.
Investors believe deep divisions remain about how to solve the debt crisis, after German Chancellor Angela Merkel on Thursday said she did not think shared euro zone bonds were needed as a way to lend to debt-stricken countries.
But while market participants see the possibility that gilts will soon outperform Bunds, which would be positive for sterling against the euro, few have seen big flows into the pound, they remain worried about signs of weakness in the UK economy.
"I'm not sure investors are buying (gilts) in significant size. They're probably not buying any more than they have been already," said Peter Kinsella, currency strategist at Commerzbank.
The widening in the Bund/gilt yield spread this week had more to do with a rise in German yields than a surge in demand for gilts, he said, while adding that a deteriorating view of the economy by the Bank of England, as outlined in its inflation report last week, was doing little favours for the pound.
"It's not as if the UK is not without its problems," he said.
The euro slipped 0.3 percent on the day to 85.90 pence.
While it remains close to an eight-month low of 84.86 pence earlier this month, the euro is on track to end the week slightly higher versus the pound, suggesting it did not suffer significantly from the recent rise in Bund yields.
The latest knock to sterling comes after BoE policymaker Ben Broadbent on Thursday said Britain risked sliding back into recession, while his colleague David Miles said more quantitative easing was possible.
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