Sterling slides to three-month lows on 'hard Brexit' fears

TOKYO/SYDNEY (Reuters) - Sterling wallowed at three-month lows in Asian trade on Monday after media reports that the British government is prepared to make a "hard" exit from the European Union rekindled investors' fears about the impact of the impending move.

Sterling stole the spotlight from the dollar, which has come under pressure in recent sessions as investors pondered what to expect from U.S. President-elect Donald Trump's economic policies after he takes office on Friday.

The pound sank as low as $1.1983 in thin early trade, depths not seen since the flash crash of early October. It last stood at $1.2032, down 1.2 percent on the day.

Dealers said the market was reacting in part to a report in The Sunday Times newspaper that British Prime Minister Theresa May will this week signal plans for a "hard Brexit" by saying she's willing to quit the European Union's single market to regain control of Britain's borders.

Investors have been worried such a decisive break from the single market would hurt British exports and drive foreign investment out of the country.

May has said she will trigger Article 50, starting the formal withdrawal from the EU, by the end of March. So far, she has revealed few details about what kind of deal she will seek, frustrating some investors, businesses and lawmakers.

May's speech on Tuesday will stress the need for Britons, who voted for Brexit by 52 to 48 percent in last June's referendum, to unite around common goals such as protecting and enhancing workers' rights.

The euro was up 0.9 percent at 0.8820 pounds, while sterling fell 1.6 percent on the perceived safe-haven yen to 137.35 yen.

The Japanese currency gained broadly, with the U.S. dollar dipping 0.3 percent to 114.13 yen, moving back toward last week's low of 113.75.

"The risk-averse sentiment stemming from the 'hard Brexit' is pushing down the dollar/yen," Masafumi Yamamoto, chief forex strategist at Mizuho Securities in Tokyo.

"But so far, I think the correction from the dollar/yen's high in December, and concerns about stronger protectionism under the new U.S. presidency have been the dominant theme."

Trump revealed few policy clues at his first press conference last week since his November election victory. The dollar rose after the election on expectations that his administration would embark on stimulus to boost growth and inflation, prompting the U.S. Federal Reserve to adopt a faster pace of interest rate hikes.

But Trump's protectionist stance has also added to some investors' risk aversion, as he has threatened to impose retaliatory tariffs on China, build a wall along the Mexican border and tear up the North American Free Trade Agreement (NAFTA).

Trump has said in the past he would label China a currency manipulator soon after he takes office.

"Our companies can't compete with them now because our currency is strong and it's killing us," the Wall Street Journal quoted Trump as saying in an interview published on Friday.

But he said in the weekend interview that he would talk to China before taking that step on his first day in the White House.

The impact of his reflationary stimulus policies, too, are also expected to be gradual rather than immediate, if they are indeed implemented.

"Even if Trump starts his domestic policies, his stimulus won't have a big impact on the country this year, rather more like next year," Harumi Taguchi, principal economist at IHS Markit in Tokyo.

"The medium term view is that the Fed is going to increase rates, and interest rate differentials will support the dollar," she said.

Buoyed by the weaker pound, the dollar index, which gauges the greenback against a basket of six major rivals, added 0.3 percent to 101.50.

The euro slipped 0.3 percent against the dollar to $1.0613.

Later this week, the European Central Bank is widely expected to hold policy steady at its regular meeting on Thursday, according to economists polled by Reuters. Last month, the ECB surprised markets by saying it would trim its monthly bond purchases to 60 billion euros starting in April.

(Reporting by Wayne Cole and Tokyo markets team; Editing by Greg Mahlich and Eric Meijer)