LONDON Sterling fell against the dollar on Friday after talks to resolve the U.S. budget crisis stalled and lacklustre UK data reinforced concerns about the economy.
Renewed worries over the U.S. "fiscal cliff", which could tip the world's largest economy into recession, helped drive investors into the highly liquid dollar and away from sterling. The pound, which is less liquid than the dollar, tends to fall when the global growth outlook darkens.
Sterling fell 0.5 percent to $1.6203, retreating from a three-month high of $1.6307 hit on Wednesday. Some strategists said it looked vulnerable to further selling.
"If the news (on the U.S. fiscal issue) remains bad for a few sessions, cable (sterling/dollar) could potentially fall due to dollar strength," said Jane Foley, senior FX strategist at Rabobank.
In the options market, near-term implied volatility rose as uncertainty about the budget talks grew. Demand to hedge against excessive price swings usually rises during times of financial uncertainty.
One-month sterling implied volatility rose to 5.05, a one-month high according to Thomson Reuters data, after hitting five-year lows around 4.15 earlier this week.
UK OUTLOOK WEAK
Data showed Britain's gross domestic product grew 0.9 percent in the third quarter of the year, revised down from the previous 1 percent reading.
The Office for National Statistics also said Britain's dominant services sector grew a meagre 0.1 percent on the month in October, which may be just enough for the economy as a whole to avoid a contraction in the last quarter of 2012.
But a bigger-than-expected rise in public borrowing added to the pound's gloomy outlook and suggested the government may struggle to get the deficit under control.
Some analysts said there could be more weakness in sterling next year if the UK economy continues to struggle to show signs of a recovery, prompting the Bank of England to ease monetary policy further.
"The big picture is still that the UK economy is stagnating, so it is still a weak fundamental growth picture," said Lee Hardman, currency economist at Bank of Tokyo Mitsubishi.
Hardman forecast sterling would fall towards $1.60 over a three- to six-month period.
A slew of weak UK data has helped drag the pound lower in the past two days. Weaker-than-expected retail sales and a sharp fall in December consumer confidence figures added to concerns the economy's performance could deteriorate.
Against the euro, sterling was close to flat on the day at 81.36 pence, not far from the 7-1/2 month high of 81.68 pence on Wednesday.
Some strategists said the pound could struggle against the euro next year if the UK budget deficit prompts ratings agencies to strip the UK of its prized AAA credit rating.
Rabobank's Foley forecast the euro to be at 83.00 pence in 12 months.
(Additional reporting by Philip Baillie; Editing by Susan Fenton)