By Anna Isaac
The British pound rose to its highest level against the U.S. dollar in a month as investors grew more optimistic about trade negotiations between the U.K. and the European Union.
Sterling strengthened 0.4% to $1.2552 Tuesday, the highest level since April 30. The currency has climbed about 2.8% over the last 5 trading sessions.
Investors are betting that the fourth round of talks between the U.K. and EU this week could see a breakthrough on a trade deal before the June 30 deadline, by which point Britain would need to request an extension to talks. The two sides have so far failed to agree on the basic elements of an accord that will determine the complex economic relationship between the U.K. and its largest trading partner.
Both economies have been hard hit by the coronavirus pandemic, and the slow progress of the talks has been a cause of growing concern for investors. British Prime Minister Boris Johnson has so far said he doesn't plan to seek an extension on the deadline to complete the talks.
"The market is building in optimism that the U.K. may be more willing to compromise in order to avoid a no-deal Brexit," said Franceso Pesole, a currency strategist at ING Bank. "Some of the economic impact of a no-deal is priced in," which means that any indication that there could be a deal leads to people exiting short positions, or bets that the pound will drop, he said.
Short positions against the pound have risen in recent weeks, but remain well below the highs seen in August last year, according to data from the Commodity Futures Trading Commission. However, traders had sold the pound for six consecutive weeks until May 26.
Rules governing fishing in U.K. waters, which have been politically fraught for both sides during the talks, are likely to be discussed by the top negotiators this week, economists and strategists at ING said on Monday. While there may not be any swift progress on the contentious issue, the EU has indicated that it may be willing to ease its position, and the U.K. also has reason to compromise, they wrote.
"Expectations are so low for a deal, that's reflected in the price," said Jordan Rochester, foreign exchange strategist at Nomura Holdings. "That increases the risk-versus-reward trade-off if something happens."
The strengthening of the pound against the dollar also reflects an increase in appetite for riskier currencies as investors grow more optimistic about the global economic recovery. Speculation that the U.K. government will step up its support of the economy in July has also bolstered the pound, analysts said.
Hopes for progress in the talks with the EU remain relatively muted among some investors and analysts. MUFG Bank, for instance, is still recommending shorting the pound.
"While a last-minute Brexit deal remains possible later this year, market participants could become more concerned over the negative implications for the U.K. economy and the pound from leaving without a deal as the year progresses," Lee Hardman, an analyst at MUFG, wrote in a note Monday.
The two sides have an end-of-year deadline to complete a deal, although they could extend that period if both sides agreed to do so by the end of this month. The ICE U.S. Dollar Index, which tracks the dollar against a basket of currencies, ticked down 0.2%.
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