Sterling fell on Friday after the European Union's Brexit negotiator said a British proposal for avoiding border problems with Ireland after Brexit "raises more questions than answers" and that there was much still to negotiate. The pound slid against both the dollar and the euro as investors focused on the differences that remain between the EU and Britain in agreeing the terms of their relationship after the UK leaves the bloc.
The weakness for sterling also comes ahead of a week in which a crucial Brexit vote in the British parliament and economic data may determine if the pound can snap its two-month losing streak.
"Generally it suggests the EU isn't fully comfortable with the UK backstop," said Lee Hardman, currencies strategist at MUFG, adding that next week the "risks are on the downside" for the pound. Sterling, which was trading down 0.2 percent before EU negotiator Michel Barnier spoke, fell further to $1.3355, half a percent lower on the day. It later recovered some of those losses.
Against the euro, sterling gave up its gains and traded flat on the day at 87.89 pence before recovering. British Prime Minister Theresa May is struggling to get her own cabinet to agree on a plan to prevent a hard border on the island of Ireland if Brexit talks fail, and on Thursday her government presented its so-called backstop arrangement.
Barnier said that the arrangement to avoid a hard border between Ireland and Northern Ireland cannot be extended to the whole of Britain, as London has proposed. A secret recording of Britain's foreign minister, Boris Johnson, warning there could be a Brexit "meltdown", published late on Thursday by BuzzFeed, has added to market worries about a divided government.
On June 12, the UK's lower house will vote on proposed amendments to the government's EU withdrawal bill. That risks fuelling a struggle between members of parliament who support and oppose a "hard" Brexit which could force a leadership challenge against May.
"As Italy's recent experience shows, political risks can come back suddenly," said HSBC economist Simon Wells in a note. "Brexit could be hotting up again." Data on manufacturing, unemployment and inflation - key gauges of Britain's economy that have struggled this year - are due out next week. After slumping 3.43 percent against a resurgent dollar in May, sterling has started June buoyed by data showing signs of a possible strengthening of the British economy.
However, Britain's economy is on course to lag behind its international peers again this year, according to new forecasts from the Confederation of British Industry.
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