LONDON (Reuters) - Sterling sank to a seven-month low against the euro on Monday as investors worried a period of political uncertainty would further weaken an economy slowing sharply before the launch of talks on leaving the European Union next week.
The pound slid to its lowest for nearly two months on Friday after shock election results left Prime Minister Theresa May short of a parliamentary majority and facing calls to step down.
Having gained a third of a percent in Asian trading, the pound fell steadily throughout the European morning, sinking by almost 1 percent on the day to 88.66 pence per euro, its weakest since early November. EURGBP=D3
It fell over half a percent against the dollar to $1.2659, just a quarter of a cent above intraday lows hit on Friday GBP=D3.
May reappointed most of her ministers on Sunday but brought a Brexit campaigner and party rival into government to try to unite her Conservatives. She is in talks with Northern Irish unionists to allow her to stay in power.
"The market's continuing to digest the election result which in our view is consistent with near-term downside risks to the pound," said Sam Lynton-Brown, currency strategist with BNP Paribas.
He added that increased uncertainty in the short term was encouraging investors to rebuild "short" bets against the pound, after they retreated from record highs over the past month. [IMM/FX]
While the motivations behind the pound's performance since Friday have been muddy, most analysts now say the pound is benefiting from the assumption that Thursday's rebuke for May will soften Britain's approach to Brexit talks.
A number of leading Conservatives on Monday stressed that membership of the European Union's single market - in exchange for freedom of movement for European workers - was not on the table. Traders assume the political machinations of the coming weeks and months may spur change on that front.
"The Conservative Party's reduced share of the vote may indicate a higher likelihood that a 'softer' form of Brexit might now be pursued, involving compromises with the EU that Ms May would not have countenanced previously, and which would be positive," analysts at ratings firm Moody's wrote in a note.
They said the election outcome was a negative for the UK's credit profile.
Six-month sterling/dollar risk-reversals, a measure of the balance in the market between bets on a currency rising or falling, stood at -1.3 GBP6MRR=ICAP according to ICAP data. A negative number indicates a bias for a weaker pound.
The political ructions come at a time when the UK is showing clear signs of slowing, despite huge injections of support from the Bank of England and an acceleration of growth to major markets in Europe.
A survey from the Resolution Foundation think tank showed almost half of British employers are unprepared for the government's planned changes to immigration rules after Brexit.
Another survey showed British business confidence falling sharply, while figures from credit card network Visa indicated British consumers cut spending for the first time in nearly four years last month.
Investors' will now watch for readings on inflation, wage growth, unemployment, and retail sales this week - all of which will play into the Bank of England's stance on record-low UK interest rates due on Friday.
Citi's Economic Surprises Index for the UK is at its most negative since Britain voted to leave the European Union last year .CESIGBP, showing data has been coming in below forecasts in recent weeks.
Deutsche Bank analysts said the election would make "helicopter money" - printing and distributing more cash in the hope people will spend it - more likely as governments balance an unwillingness to further tax older voters with demands for wealth redistribution towards younger generations.
That - or other similar monetary measures to support growth - could potentially increase the overall supply of sterling, weakening the currency.
"If the youth are now waking from their apathetic slumbering then policy surely has to be more redistributionary," they wrote. "This not a recipe for austerity and debt reduction - both are looking increasingly like political suicide."
For graphic on sterling and gilt yields, click bit.ly/2dgAXn1
For graphic on world FX rates in 2017, click tmsnrt.rs/2egbfVh
For graphic on trade-weighted sterling since Brexit vote, click tmsnrt.rs/2hwV9Hv
Editing by Alison Williams