By Nia Williams
LONDON, May 8 (Reuters) - Sterling hovered within sight of a 3-1/2 year peak against the euro on Tuesday as election results in Greece and France cast doubt on the durability of austerity plans aimed at tackling the euro zone debt crisis.
Strategists said the pound could extend gains in the near term if politicians in Greece failed to form a new government following a shock election result that left questions over the country's ability to avert bankruptcy and stick with the common currency.
But the pound fell against the dollar, dragged down as the political uncertainty in the euro zone encouraged investors to shun riskier assets in favour of the safe-haven U.S. currency.
Sterling may also come under pressure if debt contagion and economic slowdown in the euro zone started to affect the UK economy and fuel speculation the Bank of England could extend its asset purchase programme to boost growth.
"Our view is that euro/sterling will move very gradually to the downside, but the more acute the problems are in Europe the more likely it is we are going to see a negative impact on the UK economy as well," said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi.
Hardman has a 12-month euro forecast of 77 pence.
The euro was last steady at 80.59 pence, having hit a trough of 80.37 pence on Monday following the Greek election, its weakest since November 2008.
Traders said they would look to sell any rallies in the euro towards 81 pence, and most expect it will break below 80 pence.
The fall in the euro pushed the trade-weighted sterling
index to 83.9, a 33-month high.
Aside from developments in the euro zone, focus for the pound will centre on a Bank of England policy decision on Thursday.
The BoE is expected to keep interest rates on hold and the quantitative easing total at 325 billion pounds. Although the UK is in recession, market players expect persistently high inflation to prevent the bank from easing policy further for now.
Quantitative easing, which involves printing money to stimulate growth, tends to weigh on a currency and sterling could come under pressure if market players start to bet policymakers will restart the programme in coming months.
Greece's Left Coalition party, propelled into second place in the election after campaigning against the bailout deal, has been given a three-day window to try and form a coalition after New Democracy failed to make headway.
Left Coalition leader Alexis Tsipras said on Tuesday pro-bailout parties should renege on an EU/IMF rescue deal after they were rejected by voters.
This spooked markets, weighing on the euro and boosting the dollar, pushing sterling down 0.3 percent to $1.6143.
"There is an awful lot of concern out there and if that breaks loose then that will be very dollar-positive and will hit cable (sterling/dollar)," said Kathleen Brooks, research director at FOREX.com.
But sterling was "well placed to outperform the euro".
As well as uncertainty in Greece, investors were concerned about whether new French President Francois Hollande's focus on growth would clash with Germany's insistence on fiscal austerity.
(Additional reporting by Jessica Mortimer and Philip Baillie; Editing by John Stonestreet)
Copyright Thomson Reuters 2012. All rights reserved.
The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.