Sterling drops towards $1.29 as technical trigger fuels sell-off

(Updates prices, adds chart)

By Saikat Chatterjee and Sujata Rao

LONDON, Feb 5 (Reuters) - The British pound slumped to two-week lows on Tuesday after weak survey data and uncertainty about Brexit talks pushed it below a key market level, forcing some large investors to cut some bets.

While a weak Purchasing Managers' Index (PMI) report was the initial catalyst for the fall, sterling's losses accelerated after it broke convincingly below the 200-day moving average against the resurgent dollar -- an important technical level that prompted more investors to join the sell-off.

With (Other OTC: WWTH - news) uncertainty over the outlook for Brexit negotiations sapping broader demand for the pound with less than two months to go before Britain is due to leave the European Union, the currency rapidly fell more than half a percent against the dollar and euro .

"Some solid investor-style sell flows are going through the sub-$1.30 levels responding to combination of technical, economic and political sell signals," Neil Jones, head of hedge fund FX sales at Mizuho, said.

At 1624 GMT, sterling held near the day's low at $1.2925, falling 0.8 percent to its lowest level since Jan. 23. It had been higher before the PMI data, at $1.3051.

"The PMI (Other OTC: PMIR - news) report is quite disappointing and points to a softening labour market, and that adds to the general uncertainty hanging over the currency in the short term," said Credit Agricole (Swiss: ACA.SW - news) currency strategist Manuel Oliveri.

A closely watched gauge of the world's fifth-biggest economy, the IHS Markit (Stuttgart: A1139A - news) /CIPS UK Services PMI, fell to 50.1 in January from 51.2 in December -- its lowest level since July 2016 and barely above the 50 mark that separates growth from contraction.

GBP LOWER, VOLATILITY INCHES HIGHER

The pound's fall came as the dollar firmed to its highest since Jan. 25, up 0.2 percent against a basket of currencies. Once sterling fell under the 200-day moving average around $1.3037, some large investors scrambled to cut their positions in the pound, dealers said.

Some chunky option expiries around the $1.30-$1.3010 area around were also highlighted as amongst the reasons for sterling's latest leg down.

Market strategists pointed to the $1.2901, the 100 day moving average for the pound, as the next critical level for the British currency.

Against the euro, the pound sank to 88.20 pence, down 0.6 percent on the day and the weakest since Jan. 22.

Sterling has been supported in recent weeks by belief that a last-minute agreement will avert the catastrophe of a no-deal Brexit and German Chancellor Angela Merkel said on Tuesday there was still time to find a solution to the impasse.

However, jitters have returned after the Jan. 29 vote in parliament which asked British Prime Minister Theresa May to persuade the EU to accept changes to the Brexit agreement before the March 29 departure date.

With another parliament vote due in mid-February, derivatives markets are painting a cautious outlook for the pound with shorter-dated risk reversals indicating a greater bias for sterling puts over calls.

Puts are options that confer the right to sell at a certain price while call options allow a holder to buy. Two-week implied volatility, also covering the period of the vote, has crept higher.

The sterling weakness come before a Bank of England meeting on Thursday, but little clarity is expected on interest rates, which last went up in August 2018. The next move will probably hinge on how Brexit plays out.

Ten-year UK government bond yields fell five basis points on the day at $1.23 percent.

(Reporting by Saikat Chatterjee and Sujata Rao; editing by Ed Osmond and Alexander Smith)