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LONDON (Reuters) - Sterling slid towards a three-decade low against the dollar on Monday after British Prime Minister Theresa May set a March deadline for the formal departure process from the European Union to begin, sending UK shares to a 16-month high.
The pound fell more than 1 percent to $1.2841, its weakest since early July and not far from the 31-year low of $1.2798 hit on July 6, days after the June 23 referendum on EU membership. It hit a three-year low versus the euro.
Against the Bank of England's trade-weighted currency index, the pound closed at a 6-1/2-year low of 76.7, more than 1 percent down on the day following May's comments.
May told her Conservative Party's annual conference on Sunday that she was determined to move on with the process and win the "right deal", in a move to ease fears inside the party that she might delay the divorce.
She said she would invoke Article 50 no later than the end of March next year, referring to the EU's Lisbon Treaty that formally puts the divorce proceedings between the EU and Britain in place.
This means she kicks off the negotiations process before the French and German elections next year and implies the two-year Brexit clock triggered under Article 50 will wind down by March 2019, a year before Britain's next general election.
While the March deadline offers some clarity to the process and underpinned stocks, many in the market worry that the government's stance points to a "hard Brexit" where Britain quits the single market in favour of retaining control on migration.
The economy has shown resilience post-referendum, but fears of a slowdown in business investment and the wider economy will undermine the pound and raises the prospect of possible further easing by the Bank of England in the coming months.
British finance minister Philip Hammond vowed to protect the economy from any turbulence during the negotiations, assuring businesses and consumers he would act if needed.
"For market participants the key soundbite was that regaining control over EU immigration into the UK would be the priority ahead of membership of the single market," Shilen Shah, bond strategist at Investec Wealth and Investment, said. "Sterling has the potential to come under further pressure given the probable stalling of foreign direct investments."
Investors worry a "hard exit" from Europe's single market, or 'Smexit' as Royal Bank of Canada have called it, would send Britain into a recession and blow out its current account deficit, already among the highest in the developed world.
A wider current account gap and slowing foreign investment tend to act as drags on the currency.
"May's stance is a reminder that uncertainties related to 'Smexit' turbulence could be costly for the economy in the short run," said RBC Capital Markets senior economist Sam Hill.
For now though, sterling's weakness has helped British exports and the economy. Data released on Monday showed factory activity grew at the fastest rate in more than two years last month and suggested manufacturing growth in the third quarter will be the strongest so far this year.
JPMorgan raised its forecasts for growth in the third quarter and expects the British economy to expand at 1.3 percent in 2017, compared with a previous forecast for 0.9 percent growth.
The positive impact from sterling's weakness and the good news from the manufacturing sector helped Britain's blue chip FTSE 100 index reach its highest level since June 2015.
The index had fallen sharply just after the June vote, but has since recovered 21 percent, thanks to its large number of internationally facing companies that benefit when sterling falls. The benchmark index closed 1.2 percent higher on Monday.
"As a result of Prime Minister May's announcement ... the pound has weakened significantly, which is actually seen as a good thing by the FTSE 100 as it's quite an export-heavy index," Henry Croft, Research Analyst at Accendo Markets, said.
British government bond prices gained while expectations that the BOE could ease policy in February rose a tad, pricing in the swaps market showed.
Editing by Jane Merriman and Hugh Lawson