By Sujata Rao
LONDON (Reuters) - Sterling suffered its worst day in a month on Monday as fears grew that the prickly Irish border issue and disagreements within the UK ruling party over Brexit would see Prime Minister Theresa May face a serious challenge to her leadership.
The Telegraph newspaper's deputy political editor said the DUP, the Northern Irish party which props up May's government, will back an amendment proposed by rebel Brexiteer lawmakers that would effectively make the European Union's backstop proposal illegal
The news follows reports in Sunday newspapers quoting unnamed lawmakers as saying May should prepare for a challenge to her leadership.
"(The DUP report) is just reinforcing the negative sentiment towards the pound. On the weekend, we saw increasing concern over political instability in the UK and the threat of another leadership challenge back on the table," said Lee Hardman, FX strategist at MUFG in London.
Hardman said he still expected a deal eventually to be struck over Brexit but added: "The path to a deal seems to have become a bit harder."
By 1415 GMT, sterling was down 0.8 percent, having hit a low of $1.2957, its weakest since Oct. 4 and the biggest one-day fall since Sept. 20.
Against the euro, the pound was down 0.5 percent
Jittery markets are now awaiting May's speech to parliament, at which she is expected to say that 95 percent of the Brexit divorce deal has been settled. But she will maintain opposition to the European Union's proposal for the land border with Northern Ireland.
However, her proposal to extend a status-quo transition period beyond the current proposed date of December 2021 has angered the eurosceptics in her party.
Prominent Brexiteer Steve Baker will try to block the EU's backstop plan on Wednesday by attaching amendments to legislation passing through parliament that would effectively make the proposal illegal. Forty Tory lawmakers as well as the DUP are likely to support it, the Telegraph reported.
"(The leadership challenge issue) is hanging over sterling, which is (also) waiting for another steer on Brexit, likely from this address from May today," Investec economist Victoria Clarke said.
May is due to start speaking at 1430 GMT.
Late last week, Brexit optimism, along with a paring of dollar long positions, saw short sterling bets fall to a net 50,353 contracts, versus more than 60,000 the week before, calculations by Reuters and the Commodity Futures Trading Commission showed.
But analysts at Nomura said they were taking profit on long sterling positions, noting the risks in the short term.
"Despite our view that a leadership confidence vote on May is no more than hyped-up tail risk, we admit the Conservative party has never looked closer to triggering such action as it does today," Nomura said, noting that centrist Tories as well as Brexiteers were disgruntled with the direction of Brexit policy.
(Additional reporting by Tommy Wilkes; editing by Raissa Kasolowsky, Larry King)