By Elizabeth Howcroft
LONDON (Reuters) -The pound fell against the dollar on Wednesday, as Britain and the European Union failed to agree on solutions to post-Brexit trade problems in Northern Ireland, and exchanged threats in a standoff that could claim the G7 international summit.
Currency markets have been generally sluggish so far this week ahead of U.S. consumer price index (CPI) data and a European Central Bank meeting, both on Thursday, which are expected to be market-moving.
The pound had been ignoring a dispute between Britain and the EU over trading arrangements in the British province of Northern Ireland, which remained within the European Union's single market after Brexit due to its open land border with Ireland.
But the currency fell after European Commission Vice President Maros Sefcovic said that the EU is considering advancing its legal challenge to Britain over UK action in Northern Ireland, which could result in a court case by autumn or the eventual imposition of tariffs and quotas.
Brussels accuses London of breaking the agreement by failing to implement checks on some goods moving from Britain to Northern Ireland and has started legal action over the British government's unilateral extension of a grace period.
The row has been dubbed the "sausage war" by British media because it affects the movement of chilled meats from Britain to Northern Ireland.
At 1445 GMT, sterling was down 0.3% versus the dollar at $1.41165, having reached as high as $1.419 earlier in the session, before the EU's comments .
Versus the euro, it was down 0.4% on the day at 86.34 pence per euro - its weakest in one week .
Sterling-dollar implied volatility gauges with one-month maturities were at their lowest since February 2020, suggesting that market participants are not bracing for significant price-action.
"If the relationship between the EU and the UK over this does worsen, it could be a significant headwind for sterling... but I think the market would rather ignore it," said Jane Foley, senior FX strategist at Rabobank.
U.S. President Joe Biden departed on Wednesday for Britain where he will participate in the annual G7 summit. He will meet with British Prime Minister Boris Johnson on Thursday.
Foley said that market participants were likely to continue to "gloss over" the Northern Ireland trade situation, unless Biden weighs in on the issue or if there is the suggestion that a potential UK-U.S. trade deal could be at stake.
Biden will warn Johnson not to renege on the Northern Ireland Brexit deal when they meet for the first time at the G7 summit, British newspaper The Times reported on Monday, citing unidentified sources.
Given the optimism about the euro zone's economic outlook and the possible headwinds faced by Britain, the pound may struggle to break higher versus the euro in the coming weeks, Rabobank's Foley said.
(Reporting by Elizabeth Howcroft; Editing by Mark Heinrich and Jonathan Oatis)