Sterling fell against the dollar on Friday after talks to resolve the US budget crisis stalled and lacklustre UK data reinforced concerns about the economy. Renewed worries over the US "fiscal cliff", which could tip the world's largest economy into recession, helped drive investors into the highly liquid dollar and away from sterling. The pound, which is less liquid than the dollar, tends to fall when the global growth outlook darkens.
Sterling fell 0.5 percent to $1.6203, retreating from a three-month high of $1.6307 hit on Wednesday. Some strategists said it looked vulnerable to further selling. Against the euro, sterling was close to flat on the day at 81.36 pence, not far from the 7-1/2 month high of 81.68 pence on Wednesday. Some strategists said the pound could struggle against the euro next year if the UK budget deficit prompts ratings agencies to strip the UK of its prized AAA credit rating.
"If the news (on the US fiscal issue) remains bad for a few sessions, cable (sterling/dollar) could potentially fall due to dollar strength," said Jane Foley, senior FX strategist at Rabobank. In the options market, near-term implied volatility rose as uncertainty about the budget talks grew. Demand to hedge against excessive price swings usually rises during times of financial uncertainty.
One-month sterling implied volatility rose to 5.05, a one-month high according to Thomson Reuters data, after hitting five-year lows around 4.15 earlier this week. Some analysts said there could be more weakness in sterling next year if the UK economy continues to struggle to show signs of a recovery, prompting the Bank of England to ease monetary policy further. "The big picture is still that the UK economy is stagnating, so it is still a weak fundamental growth picture," said Lee Hardman, currency economist at Bank of Tokyo Mitsubishi.
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