Hard Brexit fears drive pound from 1-1/2-year high, dollar up

NEW YORK (Reuters) - The U.S. dollar rose modestly on Tuesday, lifted by a dramatic slide in the pound after British Prime Minister Boris Johnson put a no-deal exit from the European Union back on the table.

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Britain on Tuesday set a hard deadline of December 2020 to reach a new trade deal with the EU, trying to pressure Brussels to move more quickly to seal an accord. Johnson will use his control of parliament to outlaw any extension of the Brexit transition period beyond 2020. It was his boldest move since winning a large majority in Thursday’s election, and it spooked financial markets.

The pound GBP= was 1.53% lower in North American trade at $1.312 and was down 2.89% from Friday when it hit its highest since May 2018 following Johnson's victory.

“Sterling-negative Brexit uncertainty returned to the forefront,” said Joe Manimbo, senior market analyst at Western Union Business Solutions.

The move was also driven by investors unwinding pre-election positions in sterling, said Mazen Issa, senior foreign exchange strategist at TD Securities.

“There was a lot of optimism being built into sterling going into the election as the polls continued to show ... that there would be a Conservative majority,” said Issa.

“But our concern going into the election was that a good chunk of that optimism was already priced in. So, once you did have a realization of that outcome, it was an opportune time for those that rode sterling on the way up to wind down some of those positions.”

The euro rose against the pound EURGBP=, last up 1.64% to trade at 0.849 pence, its strength bolstering it against the U.S. dollar as well EUR=.

“The move appears to be the knee-jerk variety for the euro as Brexit uncertainty would only complicate Europe’s already challenging economic backdrop. A better test of euro sentiment arrives Wednesday with the final reading of euro zone inflation for November, which is forecast to go unrevised at a low 1%, compared to the ECB’s near 2% bullseye,” said Manimbo.

The dollar index .DXY was slightly higher, up 0.20% at 97.214, driven by the fall in the pound as well as a fall in the Australian dollar AUD=.

The Aussie dropped on Tuesday after Australia’s central bank opened the door to another cut in interest rates as early as February. The trade-linked currency also weakened as euphoria from the U.S.-China trade agreement faded. It was last down 0.52% at 0.685 U.S. dollar to the Aussie.

Reporting by Kate Duguid in New York, Saikat Chatterjee and Elizabeth Howcroft in London and Hideyuki Sano in Tokyo; Editing by David Gregorio and Jonathan Oatis