LONDON (Reuters) - Sterling fell to one-month lows against the dollar and the euro on Tuesday, as investors took fright at reports that Brexit talks between Britain and the European Union were close to breaking down.
With Britain is due to leave the bloc on Oct. 31, there is little sign London and Brussels can overcome their divisions, and both sides are jostling to avoid blame for a delay or a disorderly no-deal Brexit.
Britain’s proposals to replace the Irish “backstop” - an insurance policy to keep the border open between the Republic of Ireland and the British province of Northern Ireland - has been rebuffed by EU leaders.
The pound fell after a Downing Street source said German Chancellor Angela Merkel and British Prime Minister Boris Johnson had spoken and that she had made clear a deal was “overwhelmingly unlikely”.
The source said that if the call represented a new position, it meant a deal was impossible “not just now but ever”.
European Council President Tusk accused Johnson of playing “some stupid blame game”.
By 1420 GMT, the pound extended falls to touch its monthly low of $1.2196 GBP=D3, down 0.7% from Monday's close. It weakened more than 0.7% against the euro, touching a low of 89.95 pence - its weakest since Sept. 9 GBP=D3 EURGBP=D3.
“The pound has taken a lurch lower as (reports say) there is no prospect of a deal,” said Michael Hewson, chief market strategist at CMC Markets.
But he noted that a law passed last month by parliament required Johnson to seek a delay to Brexit if a deal with the EU has not been agreed by Oct. 19.
“(Sterling) is reacting to the newsflow, which is negative. But at some point it has to react to the reality, which is that there will be an extension and elections,” Hewson added.
The opposition Labour party called for lawmakers in parliament to unite to prevent a no-deal Brexit taking place at the end of October.
Analysts say a Brexit delay leading to a UK election has already been priced in as the most probable outcome.
Hypermind, a company that allows punters to “bet” on the outcomes of geopolitical events using play-money, sees the chances of a no-deal Brexit before the end of the year at 18.9%.
While Johnson has repeatedly vowed to take Britain out of the EU on Oct. 31 even without a divorce deal in place, sterling-dollar implied volatility gauges maturing around the Oct. 31 deadline were little affected by the pound’s moves. GBP1MO=FN
Data has repeatedly highlighted the extent of potential damage from a no-deal Brexit.
A report by the Institute for Fiscal Studies published on Tuesday said leaving without a deal could double Britain’s budget deficit to around 100 billion pounds ($123 billion).
Ireland presented its 2020 budget on Tuesday, which is based on the assumption of a no-deal Brexit and pledges a 1.2 billion-euro package for firms affected if Britain crashes out of the bloc.
The political jitters, and signs of economic deterioration fuelled a rally in British government bonds, with 10-year yields slipping almost 4 basis points to 0.41%, the lowest since early-September GB10YT=RR
Elizabeth Howcroft and Olga Cotago, Additional reporting by Richard Pace; Editing by Gareth Jones and Alison Williams