July 17, 2017 / 8:03 AM / a month ago

Sterling slips back below $1.31 as Brexit talks begin

FILE PHOTO: A one pound coin lies on a Union Flag in this picture illustration shot on May 3, 2017.Darren Staples/Illustration/File Photo

LONDON (Reuters) - Sterling slipped back below $1.31 on Monday, with signs of division as the Conservative government wades into Brexit talks weighing on the currency after it soared to its highest levels in 10 months.

Four days of Brexit negotiations began in Brussels on Monday with the UK papers full of warnings from academics, commentators and former senior civil servants of the chaos that the process may generate for British government and business.

The pound jumped almost 2 cents on Friday to hit $1.3113, its strongest since last September, after U.S. inflation and retail sales data came in weaker than expected, putting into doubt the prospect of a further rate hike from the Federal Reserve this year.

But sterling started the week by edging down from those highs, trading down 0.3 percent on the day at $1.3058 and 87.84 pence per euro respectively.

"It does look like there is a bit of independent sterling weakness and politics is the obvious source," said Gavin Friend, an analyst with National Australia Bank in London.

"I can't get enthusiastic about the pound at these levels. After a weekend when the Tory party has appeared to be tearing itself apart over Brexit, those people who have sterling to sell will be doing so anywhere around 1.30."

Finance minister Philip Hammond, who has championed a softer form of Brexit, bore the brunt of a series of critical newspaper stories over the weekend about what was said at private government meetings. He said he was being attacked because of his views on Brexit.

Brexit Secretary David Davis, in the Belgian capital for talks with the European Union's chief negotiator Michel Barnier a month after a first meeting, said on Monday that having "made a good start" during their last encounter, "this week we'll be getting into the real substance".

With less than two years to settle divorce terms before Britain leaves, deal or no deal, on March 30, 2019, the 27 other EU national leaders want British Prime Minister Theresa May to rally her divided nation swiftly behind a clear, detailed plan that can minimise economic and social disruption across Europe.

Investors will be watching the talks closely, with any signs that Britain will lose preferential access to Europe's single market likely to weigh on the currency.

"It seems that the British government wants to (take) major steps towards the EU in the upcoming round of negotiations ... It has for example admitted by now that it would meet its financial obligations towards the EU - an auspicious beginning," wrote Commerzbank analysts in a note to clients.

"The situation remains difficult for the pound, however, as the recent reports of domestic political quarrels in the UK show ... In the short term, it may not be a breakdown of the Brexit negotiations, but a breakdown of the British government which is the biggest risk for sterling."

Some analysts, though, said sterling's main drivers at the moment were less about politics and more about the economy and the outlook for monetary policy. Recent warnings from Bank of England policymakers that interest rates could be set to rise have provided support to the currency.

Investors will be watching British inflation data due on Tuesday closely.

"It seems that monetary policy is having more weight than the Brexit talks; if Tuesday’s inflation figures from the UK surprise to the upside, expect sterling to continue rallying," wrote FXTM strategist Hussein Sayed.

(Graphic: sterling and gilt yields bit.ly/2dgAXn1)

(Graphic: World FX rates in 2017 tmsnrt.rs/2egbfVh)

(Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv)

Reporting by Patrick Graham and Jemima Kelly; Editing by Alison Williams

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