Sterling drops on talk Britain's divorce from EU to start early 2017

(Updates with media report of EU talks to start in early 2017)

By Anirban Nag

LONDON, Aug 19 (Reuters) - Sterling fell 1 percent against the dollar on Friday, on speculation that Britain could formally begin the process of leaving the European Union early next year.

However, the pound was on track for its best weekly performance in a month after a slew of robust data drove speculators to trim record high bets against the British pound.

Data this week covering the month following Britain's June 23 referendum to leave the EU has surprised on the upside, with July consumer prices, retail sales and jobless claims all coming in better than expected.

Despite the better data, markets continue to price around 10 basis points of further easing by year-end, and traders say that should cap gains. In afternoon trade, it lost further ground on a Bloomberg report that Britain could trigger Article 50 early next year. Triggering Article 50 of the EU's Lisbon Treaty formally begins the process of leaving the bloc.

But a government spokeswoman said Prime Minister Theresa May would not invoke Article 50 before the end of this year. "We don't recognise this briefing," a Downing Street spokeswoman said when asked about the report.

Sterling fell more than 1 percent to the day's low of $1.3023, having hit a two-week high of $1.3186 on Thursday. It recovered a tad and was last trading at $1.3065, still down 0.8 percent.

"Big sell-off in sterling this afternoon amid talk the UK wants to invoke Article 50 in the first half of 2017," said Neil Wilson (Oslo: WILS.OL - news) , analyst at ETX Capital.

"This puts paid to speculation that the UK would have several years to prepare to leave the EU. The less time the UK has to get things in order, the greater the market fears the fallout."

The euro was up 0.5 percent at 86.66 pence, having struck a three-year high of 87.245 earlier this week.

Any gains for sterling in recent weeks have been shortlived, with traders tending to sell the pound on rallies.

"Our positioning metrics signal that sterling shorts had become somewhat stretched heading into this week, so the pound's ability to gain back some ground on the better data flow is not surprising," BNP Paribas (LSE: 0HB5.L - news) analysts said in a note.

"However, we think current account financing challenges remain significant for the UK and we continue to target sterling/dollar at $1.24 by quarter-end."

Britain runs one of the highest current account deficits in the developed world -- at 5 percent of gross domestic product-- and this is likely to deteriorate in coming months as the economy slows after the 'Leave' vote. As a result, many analysts expect the pound to weaken as foreign inflows slow. (Reporting by Anirban Nag; Editing by Richard Balmforth)