Sterling held near a four-month high on Tuesday as a broad U.S. dollar rout over the past week ran out of steam and negative news from Brexit negotiations prompted hedge funds to take profits.
The pound rose 0.28% higher versus the dollar at $1.2916 , just shy of a March high of $1.2977 in early Asian trading. However, it traded 0.49% weaker versus the euro at 90.82 pence.
But the pound is at risk of giving back its gains, say investors.
"We just have a bit of a pullback," said Gavin Friend at National Bank of Australia. "Sterling has been a reluctant riser against the weaker dollar and I think until we get some sort of clarity on the EU-UK trade situation, sterling is going to remain like that."
Concerns about the lack of progress of Brexit negotiations also prevented the pound from pushing above the $1.30 levels.
The European Union says a deal needs to be done by October to allow time for ratification by the end of the year. Both sides have said the talks may be stalling. Michel Barnier, the EU's chief Brexit negotiator, said a trade deal with the UK was possible, sources told Reuters on Monday.
"Looking at the various comments from Barnier, markets are pricing in more uncertainty," said Pesole. "They were probably hoping to get something a bit more tangible on the EU-UK trade negotiations."
That uncertainty was reflected in the currency derivative markets. Sterling/dollar implied volatility, a gauge of expected swings embedded in currency options, rose to a one-month high around 8.3%, boosted by the dollar's plunge this week.
Speculators and real money managers have added short positions on the British currency in the week to Tuesday, latest CFTC data showed, though the number of contracts held were not as many as a couple of months ago.
The currency's strength is also at odds with the state of the underlying economy.
After failing to curb new COVID-19 infections at the start of the pandemic, the government and the central bank have injected an unprecedented amount of money to keep the economy afloat and prevent a massive wave of unemployment. (Reuters)