Sterling rally pauses, yuan falls on U.S. friction over Hong Kong

By Stanley White

TOKYO (Reuters) - The pound pulled back from its highest level in almost five months versus the dollar on Wednesday, erasing some of the rally sparked by signs Britain is closing in on a deal to leave the European Union.

Sterling also pulled back from its highest in five months against the euro as investors took profit and prepared for a make-or-break summit between Britain and the EU on Thursday and Friday.

U.S.-China ties came into focus again as the yuan fell after Beijing criticized new U.S. legislation seen as supportive of pro-democracy protests in Hong Kong.

In global currency markets, traders nervously await the latest developments from a last-ditch effort to see whether Britain and the EU can draft an agreement on Brexit before the summit.

Reports the two sides were approaching an agreement boosted sterling overnight, though traders said the currency could swing wildly because it is still unclear if Britain can avoid postponing its departure beyond Oct. 31.

"Even if the two sides can agree something, it is unclear if they can stick with the exit deadline," said Yukio Ishizuki, foreign exchange strategist at Daiwa Securities in Tokyo.

"Whether Britain's parliament will approve whatever has been agreed is another big uncertainty. Sterling had a good run-up, but some investors are lightening their positions."

The pound fell 0.24% to $1.2757, pulling back from a five-month high of $1.2800 reached on Tuesday.

Against the euro (EURGBP=D3), the British currency fell around 0.2% to 86.48 pence. On Tuesday, sterling hit 86.25 pence per euro, the strongest since May 10.

The pound on Tuesday jumped after Bloomberg News reported that negotiators hoped an agreement would be reached by midnight on Tuesday in Europe, but a lack of news in Asia about the talks helped push the currency lower, traders said.

Without a Brexit deal, trade from Britain that previously flowed unhindered across the EU's single market would be subject to customs tariffs and safety inspections, which many fear would cause economic turmoil.

In Asia, the fresh U.S.-China strains over Hong Kong pushed the safe-haven yen higher, helping it claw back earlier losses, as worries about relations between the economic superpowers and disappointment with efforts to end their trade war marred sentiment.

In the onshore market, the yuan fell around 0.22% to 7.0973 per dollar. In the offshore market, the yuan was off more than 0.2% to 7.1028 versus the dollar.

A bruising trade war between the United States and China that has dragged on for more than a year has already placed incredible strains on relations between the two countries.

Hong Kong has been rocked by months of often violent protests against China's rule of the former British colony.

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Any signs of support from U.S. lawmakers for the protest movement is likely to draw Beijing's ire and make a resolution to the trade war less likely.

Reports of a "Phase 1" trade deal between the United Statesand China last week initially cheered markets but the dearth of details around the agreement has since curbed anyenthusiasm.

The yen rose slightly to 108.66 per dollar, pulling away from a two-month low. The yen also rose around 0.4% versus the pound (GBPJPY=) and around 0.5% against the Australian dollar (AUDJPY=).

The dollar index (DXY) against a basket of six currencies rose slightly by 0.04% to 98.323.