September 11, 2018 / 10:07 AM / 13 days ago

UPDATE 2-Sterling erases early gains as Brexit deal optimism fades

* Graphic: World FX rates in 2018 - tmsnrt.rs/2egbfVh

* Graphic: Trade-weighted sterling since Brexit vote - tmsnrt.rs/2hwV9Hv

* Sentiment boosted by EU negotiator’s comments

* Says Brexit deal possible within weeks (Adds details, updates after Hammond and Carney comments)

By Saikat Chatterjee and Tommy Wilkes

LONDON, Sept 11 (Reuters) - Sterling erased its earlier gains and fell into the red on Tuesday as a recent rise in optimism over prospects for a Brexit trade deal with the European Union faded.

The pound remained close to five-week highs, however, after EU chief negotiator Michel Barnier’s comments on Monday that a Brexit deal was possible within weeks and given that British economic data has been broadly supportive of the currency.

The latest figures, published on Tuesday, showed British workers’ underlying pay growth picking up faster than expected, although market attention is squarely focused on Brexit headlines.

The British currency hit its highest level since early August in early trading at $1.3087, but gave up its gains after the pay data to stand 0.2 percent down at $1.3002. Against the euro, the pound was flat at 89.06 pence.

News that Bank of England Governor Mark Carney would extend his term until the end of January 2020 did little to boost the pound before a policy meeting this week.

With less than seven months to go before the United Kingdom is due to leave the European Union, recent comments from policymakers have been perceived by markets as conciliatory.

Diplomats and officials said on Monday that EU leaders were likely to hold a special Brexit summit in mid-November in the hope of signing off on a divorce deal with Britain.

However, investors have shied away from big bets, given the lack of concrete progress and a few big event risks such as the ruling Conservative’s party conference at the end of September, at which Prime Minister Theresa May could face a leadership challenge.

CHEAP VOLATILITY

Derivative traders at banks have said there is increased interest from hedge funds in buying short-dated currency options on the British pound, betting that swings in the pound will intensify as the pace of negotiations picks up.

Daily swings in sterling over the past week are higher than what similar gauges in the derivative markets are indicating, encouraging speculators to buy relatively cheap options betting on a pick-up in volatility.

In the cash markets, hedge funds remain negative on the British currency, according to latest positioning data, showing a net $5.5 billion outstanding short position.

Growing expectations of a Brexit deal are eroding the safe-haven appeal for government debt, with yields on 10-year British government bonds at a one-month high and German yields also rose.

“Recent comments from the UK and the European side have been remarkably positive for the British currency, but these negotiations are by no means a straightforward affair and markets should be prepared for more volatility,” said Morten Helt, a currency strategist at Danske Bank.

Hopes of a deal breakthrough have helped sterling to rally nearly 2.5 percent from Wednesday’s lows below $1.28 and tighten five-year credit default swaps by more than a basis point from a near 1-1/2 year high hit this month.

Reporting by Saikat Chatterjee and Tommy Wilkes; Editing by David Goodman and Ed Osmond

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