By Lucy Raitano
LONDON (Reuters) -Sterling fell against the dollar on Tuesday, undermined by Britain's bleak economic and political outlook relative to other big economies, including the government's plans to ditch pre-agreed rules on post-Brexit trade with Northern Ireland.
Monday saw British Prime Minister Boris Johnson press on with plans to pass legislation through parliament to overturn parts of a Brexit divorce deal over Northern Ireland trade. The move has angered the European Union.
"If the bill passes its current form it would clearly lead to significant deterioration in relations with our major trading partner and it would be a large drag on sterling," said Colin Asher, senior economist at Mizuho.
The bill still has to pass through the House of Lords, so any potential drag on the currency is still some distance in the future, Asher said.
By 1530 GMT, the pound slipped 0.6% versus the dollar at $1.2192.
It flatlined against the euro at 86.200 pence after touching a near two-week low to the single currency.
Another potential headwind could come from Scotland where First Minister Nicola Sturgeon on Tuesday proposed another independence referendum for October 2023.
Johnson and his Conservative Party, which is in opposition in Scotland, strongly oppose a referendum, saying the issue was settled in 2014 when Scots voted against independence by 55% to 45%.
But the main focus for sterling is the UK economy, and how the Bank of England will balance tackling soaring inflation amid the growing risk of recession.
Inflation hit a 40-year record of 9.1% last month, the highest level of the G7 countries.
Traders will listen closely to Bank of England governor Andrew Bailey, who is due to speak Wednesday at a European Central Bank forum, for hints about the BoE's plans to hike rates at its August meeting.
"We're all expecting the Bank of England to hike rates by 50 basis points, that is the consensus in the market; anything that falls short will create downsides from the pound," said Ricardo Evangelista, senior analyst at ActivTrades.
"There is a degree of pessimism surrounding the UK economy and the medium-term direction for the pound is definitely bearish in my opinion," he added.
Meanwhile a poll by U.S. bank Citi and pollsters YouGov (LON:YOU) showed the British public's expectations for inflation in future years receding this month to their lowest level since January.
But analysts reckon UK inflation is yet to peak and some expect bigger 50-bps rate hikes over the summer.
"It's better to do too much and unwind next year than not do enough in the near term, as their inflation fighting credentials are being questioned," said Mizuho's Asher.
Aggressive rate hikes are also expected from the Fed, but the U.S. central bank is expected to pause hikes towards the end of the year. The resulting narrowing of interest rate spreads should support sterling, he said.