Sterling stabilised on Thursday as prospects for a Brexit deal appeared to improve, with Britain giving it a 66% chance of success.
The pound inched up towards $1.30 in early session, before giving back some of those gains. A media report suggested officials might be more optimistic than they were letting on in public.
British Prime Minister Boris Johnson and European Council President Charles Michel agreed on Wednesday that some progress had been made in talks on a trade deal, though significant differences remained.
Analysts said a Bloomberg News report that in private officials were more optimistic about the likelihood of clinching a deal that official statements would suggest, helped sentiment.
“In any case, next week’s EU Council meeting is not the hard deadline we had thought it would be but rather yet another ‘stock-taking exercise’,” said Marshal Gittler, head of research at BDSwiss.
The pound was last trading flat both against the U.S. dollar and the euro at $1.2922 and at 90.04 pence respectively.
Yet an overnight rise in implied volatility gauges to a two-month high of above 12% in sterling, suggested traders were prepared for unexpected moves in the currency as more Brexit talks continue this week.
“The improving mood music surrounding the Brexit talks is encouraging a stronger pound,” said Lee Hardman, currency analyst at MUFG. However, coronavirus concerns could cap the currency, he added.
“The more severe the lockdown becomes the more likely positive Brexit developments will be overshadowed,” he added.
The British government is considering additional local COVID-19 restrictions for parts of northern England as the second wave of infections accelerates.
Bank of England Governor Andrew Bailey said he did not expect the new wave to be as damaging as the first and voiced optimism about the Brexit deal’s prospects.
He also said that risks to Britain’s economy were “very much on the downside” and that the central bank was ready to use its policy firepower to limit the impact of a second wave of COVID cases.
Bank of America analysts said “investors are under-pricing no-deal risks.”
“Though a deal remains our base case we argue that this is no longer the binary outcome for the pound that it was once,” the analysts said, giving as explanation that “UK red lines prevent a deep and comprehensive relationship with the EU” and that a deal would still represent a hard Brexit.
Reporting by Olga Cotaga; Editing by Tomasz Janowski and Raissa Kasolowsky