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LONDON (Reuters) - Sterling traded close to a three-week low against the dollar on Friday, recording a second week of losses against a greenback that has risen sharply on expectations for a faster-than-anticipated increase in U.S. interest rates.
The U.S. currency soared to 14-year highs against a basket of currencies this week after the Federal Reserve on Wednesday hinted that rates could rise three times over the course of next year - up from a forecast of two hikes at the Fed's September meeting.
Sterling - already weak because of Brexit concerns - skidded along with other currencies, hitting a low of $1.2378 on Thursday, its weakest since Nov. 23, and closing the day more than 1 percent down - its weakest performance in two months. On Friday it edged up to $1.2439 in thin trading volumes.
"A lot of moves at the moment are related to end-of-year thin liquidity and down to the fact that everyone is trying to close positions into the end of the year, rather than fundamental factors," BNP Paribas currency strategist Clara Leonard said.
The pound has been stronger over the past six weeks, registering its best month in eight years in November and threatening to break back towards $1.30 for the first time since the start of September as worries that Britain will lose access to the European single market faded.
But worries over the start of formal negotiations on Britain's exit from the bloc, due to start in the first half of next year, have continued to weigh.
"The pound is still very undervalued from a long-term perspective so there’s obviously a lot of risk and uncertainty already priced at these levels," said MUFG currency economist Lee Hardman. He said he expected sterling to stabilise around the low $1.20s over the coming months.
Against the euro, sterling was flat at 83.80 pence.
The pound had tumbled more than 16 percent on a trade-weighted basis in the wake the Brexit vote in June, but has since recovered almost half of that. It is now around 9 percent weaker than before the EU referendum against the Bank of England's trade-weighted index.
The BoE said on Thursday this could soften an expected surge in British inflation next year.
"We think it’s unlikely that the BoE will take a more hawkish stance despite this rise in inflation, because Brexit uncertainty remains," said BNP Paribas's Leonard. Like most of the market, the bank reckons interest rates will remain at their record lows for the whole of 2017.
Editing by Alison Williams