LONDON (Reuters) - Sterling erased its earlier gains and edged lower on Tuesday as a rise in optimism over prospects for a Brexit trade deal with the European Union faded.
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 0.1 percent down at $1.3011. Against the euro, the pound was flat at 89.12 pence.
“If the currency market is anything to go by, the markets are too pessimistic about the possibility of a no-deal Brexit,” said Mike Bell, a global markets strategist at JP Morgan Asset Management in London.
Still, the pound remained close to five-week highs 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 supportive of the currency.
With less than seven months to go before Britain is due to leave the European Union, derivative traders at large banks report an increase in volatility trades on the British currency rather than taking directional calls.
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 though, hedge funds remain negative on the British currency, according to latest positioning data, showing a net $5.5 billion outstanding short position.
“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.
Latest economic figures on Tuesday showed British workers’ underlying pay growth picking up faster than expected, although market attention is squarely focussed on Brexit headlines.
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.
Though comments from policymakers have been perceived by markets as conciliatory, sterling remains the most volatile currencies among the majors with expected swings in currency fluctuations doubling over the past month to the highest in six months.
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 events such as the ruling Conservative’s party conference at the end of September, at which Prime Minister Theresa May could face a leadership challenge.
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.
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 Alison Williams