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Europe, Forex

Sterling weakens after British economy shrinks in second quarter

* Graphic: World FX rates in 2019

* Graphic: Trade-weighted sterling since Brexit vote (Updates prices, adds context and chart)

By Olga Cotaga

LONDON, Aug 9 (Reuters) – The pound fell on Friday to match its lowest levels since January 2017 after data unexpectedly showed that British gross domestic product contracted in the second quarter for the first time since 2012.

The currency then pared some of the losses, though it remained weaker on the day and not far from its more than two-year lows.

Economic growth fell at a quarterly rate of 0.2% in the three months to June, below all forecasts in a Reuters poll of economists that had pointed to a flat reading.

Year-on-year economic growth slid to 1.2% from 1.8% in the first quarter, Britain’s Office for National Statistics said, its weakest since the start of 2018.

Sterling plunged to $1.2080, matching the 31-month low it reached on Aug. 1, and was last down by 0.4% at $1.2087.

Against the euro, the pound sank to a new two-year low of 90.70 pence, trading last 0.6% weaker at 92.66 pence.

British government bond yields recovered slightly after declining shortly after data was released.

London’s export-heavy blue chip FTSE 100 index briefly pared its earlier losses as sterling weakened. Companies in the index can benefit from a falling pound because they earn revenue in other currencies.

A report in the Financial Times that Prime Minister Boris Johnson was planning to hold a parliamentary election in the days after Brexit if lawmakers sink the government with a no-confidence vote has also weighed on the pound.

It is growing increasingly likely that Johnson will face a vote of no confidence soon after Sept. 3, when parliament returns from its summer recess, analysts say.

Johnson says Britain must leave the EU on schedule on Oct. 31, with or without a deal with the bloc. Delaying an election until after Brexit could be a tactic to ensure that happens even if parliament withdraws support for his government.

Vasileios Gkionakis, global head of forex strategy at Lombard Odier, said he was worried about a general election, but also said he was ready to unload some of the sterling short positions he had accumulated a couple of months ago because a lot of bad news had been already priced in the pound.

“If no-deal (Brexit) increases in probability, then of course sterling would be a sell, but until then I’m becoming a bit more neutral,” Gkionakis said, adding that he expects sterling to “settle around $1.20” before market participants reassess their expectations of Britain crashing out of the European Union without a divorce deal in October.

After becoming prime minister last month, Johnson said he was looking to negotiate a deal with the EU, but he also demanded that Brussels show a willingness to change the deal it agreed with his predecessor. The EU has repeatedly said it will not reopen the negotiations.

The pound was the second-worst performing currency in developed markets since Johnson became prime minister on July 24.

Weaker growth in the second quarter has failed to boost investors’ expectations that the Bank of England will cut interest rates in September, but some economists expect the central bank to soon embark on more easing.

“As uncertainty continues to loom over the UK economy, the difficult run of data is expected to continue and the BoE will need to consider its next step carefully as its global peers embark on further rate cuts,” said Geoffrey Yu, head of the UK Investment Office at UBS Wealth Management.

Money markets are pricing in a 25 basis points cut by January next year.

(Reporting by Olga Cotaga)

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