* 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
By Jemima Kelly
LONDON, Dec 20 (Reuters) - Sterling edged up against the dollar and euro in a quiet day of trading on Wednesday, with investors cautious about taking on large new positions on the currency ahead of the Christmas holiday and phase two of the Brexit talks next year.
With thin trading and little economic data to shift interest elsewhere, focus on the next round of divorce negotiations between Britain and the European Union left the pound unable to break outside of the ranges it has traded in over the past two weeks despite some progress in Brexit talks.
The European Union wants a transition period after Brexit to end no later than the last day of 2020, according to the European Commission’s negotiating directives agreed on Wednesday.
The BBC reported on Wednesday that the Bank of England will allow European banks to continue selling their services in the United Kingdom without having to create expensive subsidiaries after Britain leaves the EU, giving sterling some marginal support.
“While I think sterling may recover slightly into the year-end, all the optimistic talk can’t cover up the inherent impossibility of the contradictory wishes of the British side. I think sterling is still a long-term short,” said ACLS Global strategist Marshall Gittler.
Prime Minister Theresa May last week secured a deal to move negotiations to the next stage, so that post-Brexit trade and a transition arrangement can be discussed.
She told her cabinet on Tuesday that Britain’s objective in leaving the EU should be a deal that enables it to set rules suited to its situation.
Sterling edged up 0.2 percent on the day to $1.3406 . Against the euro, it inched up 0.1 percent to 88.37 pence.
MUFG currency strategist Lee Hardman said the Office for National Statistics’ confirmation on Tuesday that UK labour costs are on the rise bolstered the bank’s view that the Bank of England will raise rates next year earlier than the market expects.
“Our bullish view for the pound is based on our expectation that the MPC (monetary policy committee) will have to raise rates twice next year and the market is barely priced for one increase,” Hardman wrote, adding that MUFG expects a hike in May.
Earlier on Wednesday, a survey showing fewer British employers plan to hire extra staff next year due to one of the gloomiest economic outlooks since the vote for Brexit in June 2016 had little impact on the pound. (Editing by Andrew Roche)