Sterling falls as dollar climbs, EU customs union concerns weigh

LONDON (Reuters) - The British pound fell on Friday as the U.S. dollar resumed its rally, with confusion about whether Britain would stay in the European Union’s customs union after it leaves the bloc also weighing on the currency.

Prime Minister Theresa May said on Thursday Britain would leave the EU customs union after Brexit but a source said London was considering a backstop plan that would apply the bloc’s external tariffs beyond December 2020.

Earlier this week, the Telegraph newspaper reported that Britain would tell Brussels it was prepared to stay in the customs union beyond a Brexit transitional arrangement.

As markets digested the reports, the pound initially rose before falling back. It declined further on Friday, particularly in later European trading, when the dollar extended its gains across foreign exchanges.

“Markets are still uncertain about where we are going to be on the other side of the transition deal,” said Adam Cole, chief currencies strategist at RBC.

“It is not going to immediately attach a 100 percent certainty of us remaining in the customs union,” he said, adding that the market wanted to see evidence Britain would permanently remain inside the customs union, and not just temporarily while other issues were resolved.

Sterling dropped 0.4 percent to $1.3457, very close to the 2018 low of $1.3452 it hit earlier this week.

Against the euro the pound had earlier fallen 0.2 percent to 87.475 pence per euro before recovering to trade flat.

Sterling has slumped in recent weeks, particularly against a dollar enjoying a broad and rapid recovery.

While risks around the sort of post-divorce relationship Britain can agree with the EU have influenced the pound this week, the biggest reason for sterling’s fall has been a drastic shift in market expectations of when the Bank of England will raise interest rates.

Recent weak economic data mean markets are now not even pricing in a full 25 basis point hike by the end of 2018, against previous expectations of two 25 bp rises this year.

“We still think the risks are to the downside ... The risk is you keep on pricing out rate hikes,” Cole at RBC said.

Lukman Otunuga, an analyst at currencies broker FXTM, said that from a technical point of view a “breakdown below $1.3470 could open a path towards $1.3360”.

Reporting by Tommy Wilkes; Editing by Catherine Evans