A denial by Prime Minister Theresa May's spokeswoman of a newspaper report knocked sterling off highs but it remained up on the day, with analysts citing a growing sense among some investors that Britain will not be leaving the EU on March 29.
Two of the biggest donors to the Brexit campaign told Reuters they now believe the project they championed will eventually be abandoned by the government, underlining the uncertainty about what will happen after March 29, Britain's scheduled departure date.
Data published on Friday showed Britain's economy cooled in the three months to November, but the focus remained on May's efforts to get her Brexit deal through parliament.
A series of setbacks suffered by May in parliament ahead of the vote on her Brexit deal next week had pushed sterling to a one-week low against the euro before London's Evening Standard, quoting British cabinet ministers, reported that Britain could extend Article 50, which determines the exit date.
On Friday sterling rose as much as 0.6 percent to $1.2851, its highest since late November, before settling around $1.28. The British currency is headed for its best week since early November.
Against the euro the pound gained 0.7 percent to 89.615 pence.
Not all analysts are agreed that a delay to Britain's Brexit date will benefit the UK.
"Politicians love to kick the can down the road but there is a cost associated with that. Consumer confidence has weakened, business confidence has weakened so that time comes with a cost," said Mike Bell, global market strategist at JP Morgan Asset Management.
Parliament is due to vote on May's withdrawal deal, agreed with Brussels, on Jan. 15, but the prime minister looks set to lose the vote.
The run-up to the parliamentary vote is likely to dominate trading of sterling but the consequences of its outcome for the British currency are far from clear.
"I can see a scenario where we fall to $1.10 and I can easily see a scenario when we move to $1.45," said Fahad Kamal, chief market strategist at Kleinwort Hambros.
"The range is massive and the conviction is little. There's nobody in the world who would surmise how this will turn out."
British lawmakers have demanded a quick plan B if May loses the vote and that could reduce the chances Britain will leave the EU without a divorce deal.
Despite the uncertainty, the risk that sterling will fall against the dollar is its lowest in more than four months, according to one-month risk reversals, a gauge of market positioning. <GBP1MRR=FN>
Expectations for sterling price swings have also diminished in the last few sessions. <GBP1MO=>
"A no-deal Brexit has become less likely. But anyone who tries to make a prediction of what the Brexit outcome will be is only deluding themselves," said Sarah Hewin, chief Europe economist at Standard Chartered.
"Both extremes look live – the chance of a no-Brexit and the chance of a no-deal Brexit."
Graphic: World FX rates in 2018 http://tmsnrt.rs/2egbfVh
Graphic: Trade-weighted sterling since Brexit vote http://tmsnrt.rs/2hwV9Hv
(Additional reporting by Tom Finn and Josephine Mason; Editing by Gareth Jones)
By Tommy Wilkes and Sujata Rao