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Dollar gains against sterling on Brexit worries, U.S. growth bets

John Phillips | Digital Editor | CNBC

The U.S. dollar hit its highest level in two months against the sterling on Wednesday on concerns over next year's Brexit negotiations, while expectations of higher U.S. economic growth also underpinned the greenback.

Sterling fell as much as 0.5 percent to a session low of $1.2201, its weakest since Oct. 31. Britain faces uncertainty next year over Brexit negotiations. In October, Prime Minister Theresa May said she would trigger the process to leave the EU by the end of March.

Expectations that U.S. President-elect Donald Trump's incoming administration would boost U.S. growth through fiscal stimulus also continued to bolster the dollar.

The dollar index, which measures the greenback against a basket of six major rivals, has gained 4.9 percent this year. All those gains have come after the Nov. 8 U.S. election.

"This is just a continuation of the trend" of dollar strength, said Axel Merk, president and chief investment officer of Palo Alto, California-based Merk Investments. "People are trying to be aligned with the winning positions."

Merk said the challenges in Britain were not going away given the Brexit talks, and that "doesn't bode well for sterling."

The euro fell about 0.5 percent against the dollar to a one-week low of $1.0408, while the dollar fell about 0.2 percent against the yen to of 117.15 yen after hitting a six-day high earlier in the session.

The dollar index was last up 0.3 percent at 103.31 after hitting an eight-day high of 103.63 earlier. That remained below a 14-year peak of 103.650 struck Dec. 20.

The euro hit its one-week low against the dollar even though contracts to buy previously owned U.S. homes fell in November to the lowest in nearly a year, according to National Association of Realtors data.

Merk of Merk Investments said the theme of dollar strength continued despite the weak data, while thin trading volumes could be leading to unpredictable moves with many traders on vacation.

Some analysts said another source of euro weakness was the rise in the European Central Bank's estimates of how much additional capital will be needed to prop up Italian bank Monte dei Paschi di Siena.

"Our case is that there's probably a bit more room for (the dollar) to run," said Dominic Bunning, a strategist with HSBC in London.

With little evidence of much speculative money at work in reduced holiday volumes, Bunning said there was likely to be steady pressure on the pound from Britain's large current account deficit — seen as an important weakness as the government heads into negotiations on its EU exit.

"In a world where you have a current account deficit that is 5 or 5.5 percent of GDP ... the pressure on the currency will continue to weaken it if there isn't capital to finance that deficit," he said.

Trump's concern over the rate of the Chinese yuan is well known, but BNY Mellon strategist Simon Derrick also points to similar comments he made earlier this year on Japan's drive to weaken the yen.

"While the market collectively may not be focusing on the story, dollar strength could become a domestic political issue in 2017 should it persist," said Derrick.

"Should the dollar make substantial gains from here, particularly against the yen, it will be interesting to see how president-elect Trump responds given his previous comment," he said.