The pound hit 8-month highs versus the dollar on Tuesday, driven by weakness in the U.S. currency, but analysts were cautious about the outlook for sterling as a new round of Brexit talks began, with euro-sterling still firmly above 90 pence per euro.
The dollar index hit new two-year lows on Tuesday, facing the triple woes of diminishing yields, weak U.S. economic data and decreasing demand for safe havens.
Meanwhile, traders are braced for renewed sterling volatility as talks between Britain and the European Union restarted.
“Sterling’s recent good performance and resilience to grim economic data has likely relied on the Brexit story being put on the backburner by investors,” wrote ING strategists Chris Turner, Francesco Pesole and Petr Krpata.
“We see a non-negligible risk of markets starting to price back in a no-deal outcome,” they added.
Britain left the EU in January and is in a transition period during which the country remains in the bloc’s single market and customs union. The transition period will finish at the end of 2020 whether or not a trade deal has been reached.
At 1435 GMT, the pound was at $1.3220, up 0.9% since New York’s close. As the dollar weakened sterling hit $1.3276, its strongest since the last day of 2019.
Versus the euro, it was up around 0.3% but still above the key 90 pence per euro level, at 90.3.
Analysts say the impact of dollar weakness on the pound-dollar pairing masks sterling’s true weakness, with the effect of Brexit-related headlines more likely to be visible in euro-sterling.
But euro-sterling has been stuck in a narrow range: after monthly moves of more than 2% in February, March, April and May, the monthly change was less than 1% in June and July.
The options market suggests investor nervousness, with risk reversals, the difference between call and put option demand, showing investors still prefer options to sell the pound – although less than in March .
Prime Minister Boris Johnson’s spokesman said on Monday that Britain still believes a deal can be reached in September.
The trade negotiations are scheduled for up to Oct. 2, less than a fortnight before an EU summit. The EU has said negotiators must seal any deal by October to allow for ratification by the bloc’s 27 nations.
Jefferies analysts wrote in a note to clients that an improving net savings balance, possible good news on Brexit and the Bank of England’s quantitative easing could help the pound.