After years of wrangling, the two sides are edging towards the basis for a treaty allowing Britain to avoid no-deal exit
Sterling tumbled Thursday after Prime Minister Boris Johnson's key ally in parliament said it "could not support" his plans for a Brexit deal, throwing a spanner in the works just as Britain and the European Union were closing in on an agreement.
After years of wrangling, the two sides said Wednesday they were edging towards the basis for a treaty allowing Britain to avoid no-deal exit, which many observers warned could be economically catastrophic.
With both teams working through the night, EU negotiator Michel Barnier said there had been "good progress, and work is ongoing", while France's deputy foreign minister said Thursday a deal was "within reach but is not guaranteed".
There had been optimism that a deal was in the offing, just two weeks before Britain is due to leave the bloc, as they worked towards a solution on the vexed question of British-ruled Northern Ireland.
But Northern Ireland's Democratic Unionist Party (DUP) dropped a bombshell hours before the start of a crunch EU summit Thursday, saying it cannot support the plan.
"As things stand, we could not support what is being suggested on customs and consent issues, and there is a lack of clarity" on Value Added Tax, the DUP, which props up Johnson's government, said in a statement on Twitter.
"We will continue to work with the Government to try and get a sensible deal that works for Northern Ireland and protects the economic and constitutional integrity of the United Kingdom."
DUP leader Arlene Foster had met Johnson several times this week to discuss the progress of talks and had described as "nonsense" previous reports that she was ready to give way.
The pound, which earlier in the day was hovering at five-month highs around $1.2877 sank to $1.2750, while it also lost ground to the euro.
The DUP are against any deal that would tie Northern Ireland to EU rules but cut the rest of the United Kingdom loose.
Jeffrey Halley, senior market analyst at OANDA, said: "The DUP holds the balance of power and thus their voice counts much more than it otherwise would. Without them, the entire edifice crumbles, and we are back to the Groundhog Day Brexit extension and negotiation cycle."
In early trade, London's FTSE 100 and the DAX 30 in Frankfurt each eased 0.1 percent, while the CAC 40 in Paris was off 0.4 percent.
In Asia, most markets were in the red, with traders unable to take advantage of weak US retail data that raised the chances of another Federal Reserve interest rate cut. Comments in the Fed's Beige Book update on the economy also pointed to a slowdown.
Hong Kong rose 0.5 percent but Shanghai finished 0.1 percent lower and Tokyo lost 0.1 percent.
Sydney sank 0.8 percent, Singapore shed 0.7 percent and Seoul retreated 0.2 percent, with Wellington and Manila also off. There were gains in Taipei, Mumbai, Bangkok and Jakarta.
Speculation about a possible US rate cut provided support to higher-yielding currencies against the dollar, with the Australian dollar 0.6 percent up and the South Korean won 0.1 percent stronger. The Thai baht, the Mexican peso and the South African rand also posted healthy gains.
Oil prices fell after data pointed to a sharp rise in US stockpiles that reinforced worries about the impact on demand from the China-US trade war and the global economic slowdown.