By Richard Leong
NEW YORK (Reuters) - The sterling stumbled to its weakest against the dollar in 31 years on fears over Britain's looming exit from the European Union, while the euro recovered much of its losses on a report that suggested the European Central Bank might scale back its bond purchases.
The dollar broadly strengthened on upbeat economic data and bets on a year-end U.S. interest rate increase.
The pound has fallen almost 2 percent since British Prime Minister Theresa May's announcement on Sunday that the formal process to take the nation out of the EU would start by the end of March.
"Everything people are hearing from the UK is not positive for its currency," said Paresh Upadhyaya, director of currency strategy at Pioneer Investments in Boston.
Many in the market worry that the British government's stance points to a "hard Brexit," in which Britain splits entirely from the single market in favor of retaining control over immigration, which could drive an exodus of banks from London.
The sterling was down 0.8 percent at $1.2738 <GBP=D4> after falling earlier on Tuesday to $1.2720, its weakest since June 1985. It has declined about 15 percent since Britain's June 23 referendum on EU membership.
The pound was down 0.8 percent at 87.94 pence per euro after setting a three-year low against the single currency earlier Tuesday. <EURGBP=>
In addition to the pound and euro, the greenback rose against four other major currencies as measured by the dollar index. It was up 0.5 percent <.DXY> after hitting a 13-day high following an upbeat survey of the U.S. manufacturing sector on Monday. The encouraging report caused investors to raise their bets on a rate increase by the end of the year. <ECONUS>
On Tuesday, Richmond Federal Reserve President Jeffrey Lacker said there was a strong case for raising interest rates and that borrowing costs might need to rise significantly to keep inflation under control.
U.S. interest rates futures suggested traders see a 63 percent chance the Fed will raise rates at its Dec. 13-14 meeting, up a touch from late on Monday, according to CME Group's FedWatch program. <FFX6>
The euro pared its earlier drop following a Bloomberg report that said the European Central Bank will probably gradually wind down bond purchases before the end of its quantitative easing program, which is intended to help the euro zone economy.
"That gave the euro a bounce, but the euro zone is still continuing to work through its issues. There is only so much you could do with QE and negative rates," said Minh Trang, senior FX trader at Silicon Valley Bank in Santa Clara, California.
The single currency was down 0.1 percent at $1.1202 after falling to a near two-week low at $1.1135 earlier Tuesday. It was up 1.2 percent at 115.14 yen, not far from a three-week peak. <EUR=> <EURJPY=>
(Additional reporting by Jemima Kelly; in London; Editing by Andrew Heavens and Lisa Von Ahn)