* Graphic: Trade-weighted sterling since Brexit vote
(Updates prices)
By Olga Cotaga
LONDON, Aug 12 (Reuters) - Sterling clawed back some groundon Monday, benefiting from political ructions in Italy that hitthe euro, but concerns over Brexit kept the UK currency withinsight of multi-year lows.
The pound was up by 0.1% against the euro at 92.98 pence,after Deputy Prime Minister Matteo Salvini threatened to bringdown Italy's coalition government. Euro weakness also helpedsterling rise by 0.4% to $1.2071, its biggest daily move inthree weeks.
An unexpected second-quarter contraction in Britain'seconomy had late last week sharpened the market focus on fearsthat the country will crash out of the European Union at the endof October without a transitional deal.
Late on Sunday, sterling plunged to 93.26 pence against theeuro
"A significant compression of UK (debt) yields and Brexitundertones" are why sterling dropped against the euro, saidKamal Sharma, forex strategist at Bank of America Merrill Lynch.This is a "natural breeding ground for sterling losses," hesaid. The spread between 10-year British Gilt yields and USTreasury yields contracted on Monday to its lowest level sinceend of June
Low liquidity and media reports that Ireland will not renegotiate the Brexit backstop at an expected meeting withBritish Prime Minister Boris Johnson this month also weakenedsterling, analysts said.
The backstop, part of the withdrawal agreement that formerPrime Minister Theresa May struck with Brussels in November butBritish lawmakers failed to ratify, is a major sticking point inefforts to agree an orderly exit.
With the Brexit deadline approaching, leveraged fundsincreased their net short positions on sterling in the week toAug. 6 to a total of $7.83 billion, the highest since April2017, according to CFTC data.
Three-month risk reversals, which encapsulate the Oct. 31Brexit deadline, paint a similar picture, showing investors arebetting the pound is more likely to fall rather than rise in thenext months.
TIME TO BUY UK GILTS
As currency traders offloaded the pound, some fixed incomeinvestors viewed opportunities to buy UK government bonds.
Gilts would rally if the Bank of England were to cutinterest rates in case of a disorderly British exit from the EU,said Mohammed Kazmi, portfolio manager of the UBAM AbsoluteReturn Low Vol Fixed Income Fund at Union Bancaire Prive.
Money markets are pricing in a 25 basis-point interest ratecut by the BoE by January.
"It does make Gilts more attractive," Kazmi said, especiallyin an environment of negative yields across continental Europe."Weve been holding more duration across our funds and we thinkof shifting that (view) into the UK," he said.
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^Sterling plunge towards $1.20
^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> (Reporting by Olga Cotaga; Editing by Toby Chopra) ((olga.cotaga@thomsonreuters.com))
