Sterling on Tuesday recovered some of the losses suffered after two ministers quit over the government's Brexit plans, with markets expecting Theresa May to survive as prime minister to start negotiating her blueprint with the European Union.
The pound's gains were limited, however, after official gross domestic product data came in broadly in line with expectations.
The resignations of Foreign Secretary Boris Johnson and Brexit minister David Davis shattered May's attempt at presenting a unified cabinet approach for life after Britain leaves the European Union. May had unveiled her hard-fought and long-awaited Brexit blueprint on Friday.
The pound tumbled more than a cent to below $1.32 on Monday amid speculation that May would face a leadership challenge, plunging Britain into deeper political turmoil less than nine months before it is to exit the EU in March 2019.
May's office said on Monday she would fight any challenge to her leadership and at a meeting with her Conservative Party lawmakers she was cheered and applauded by many.
Even if May is safe for now, the big question for markets is whether Brussels will go along with her plan as a new round of negotiations begin later this month.
Markets had welcomed May's proposals as they retain close trade ties with the EU.
"On our baseline, both the eurosceptics in the Conservative Party and the EU's Brexit negotiators in Brussels give Ms. May’s Chequers proposal the benefit of the doubt - for now," said analysts at Goldman Sachs, referring to the prime minister's Chequers country home where Friday's Brexit plan was agreed.
The analysts, however, said risks to the baseline had risen. Parliamentary arithmetic could frustrate May's ability to win legislative approval for her plan and the EU may demand more concessions from Britain, angering pro-Brexit ministers.
Sterling rose to as high as $1.3301 - roughly where it was on Friday before the resignations - until the weaker data knocked it back to $1.3247, down 0.1% on the day.
Against the euro sterling also gave up some gains but remained 0.1% higher at 88.520 pence per euro .
UK five-year credit default swaps, a form of insurance against debt default, stood at 24 basis points according to IHS Markit data, the highest level since May 29 but unchanged since Friday. The FTSE 100 was broadly flat while UK government bond yields rose after falling on Monday.
"We believe a deal will be reached, but it will take time and until then, concerns about a no-deal outcome will likely intensify," economists at UBS Global Wealth Management said.
Traders are preparing for a raft of British economic data that may heighten expectations of a Bank of England interest rate rise.
The improvement in data and upbeat comments from BoE Governor Mark Carney has lifted expectations of an August rate hike to more than 70% from less than 50% two weeks ago. (Reuters)