LONDON: The pound rallied on Tuesday (Oct 15) to levels last seen five months ago as speculation on an imminent Brexit deal gained traction, dealers said.
Sterling got an early boost from the European Union's top Brexit negotiator flagging the possibility of a divorce agreement this week, reviving hopes that Britain might yet avoid crashing out of the bloc without a deal.
With the exit deadline on Oct 31, Michel Barnier's comments rekindled hopes that a compromise might be taking shape.
The British currency then got another shot in the arm when reports suggested that negotiators in Brussels were getting close to a deal.
It hit US$1.28 in the late London afternoon, a level last seen in May. It also rose strongly against the euro.
Sterling jumped "as reports said UK and EU negotiators are closing in on a draft Brexit deal," said Neil Wilson, Chief Market Strategist at Markets.com.
'WHIRLWIND OF DIPLOMACY'
Earlier Barnier told reporters: "This work has been intense all along the weekend and yesterday because even if the agreement will be difficult - more and more difficult to be frank - it's still possible this week."
Even before he spoke, Britain's Daily Telegraph had said a divorce agreement was forming, with EU and British negotiators hailing a positive day of talks on the Northern Ireland issue.
The paper quoted unnamed sources as saying there was "cautious optimism", while the BBC said the EU was considering holding an emergency summit to push through a possible deal. It said there was not enough time to get anything done before a summit set for this week.
The pound had come under pressure on Monday after European officials played down the chances of an agreement that had been aired by British Prime Minister Boris Johnson and his Irish counterpart Leo Varadkar last week.
David Kelly at JP Morgan Asset Management said the Johnson-Varadkar talks had sparked a "whirlwind of diplomacy between the British government and the Europeans to try to come up with an agreement this week".
Analysts were quick, however, to put reports into perspective and warned investors against getting ahead of themselves.
"These kind of reports expose just how vulnerable sterling is to headline risk," cautioned Wilson. "At present these are unconfirmed reports and need to be verified."
David Cheetham at XTB called the Brexit news "encouraging" but also said that "this is another example of the markets honing in on the positive aspects while looking through the negative, a recurring theme of late that has been a key driver behind the recent gains in the currency".
In equity trading meanwhile Wall Street extended opening gains, with the Dow Jones index trading solidly higher by the end of the New York morning.
Eurozone stock markets also powered ahead, gaining more than one percent by the close, while London ended steady as the strong pound weighed on stock prices.
Asian equity markets had earlier closed mixed as investor caution returned, replacing the optimism fanned by Donald Trump's partial China trade deal.
While Friday's mini-agreement between the world's economic superpowers put off fresh tariffs and saw them reach common ground on some issues, observers pointed out it was light on detail and left other major levies in place.
And despite Trump's insistence that the "phase one" agreement was "the greatest and biggest deal", Beijing said it wanted to hold more talks and called for a delay in other tariffs due in December before it would sign.
Meanwhile the IMF added to global worries about growth, saying on Tuesday that the world economy is slowing to its weakest pace since the global financial crisis, amid continuing trade conflicts that have undercut business confidence and investment.
Key figures around 1540 GMT:
Pound/dollar: UP at US$1.2743 from US$1.2555 at 2040 GMT
Euro/pound: DOWN at 86.62 pence from 87.79 pence
Euro/dollar: UP at US$1.1036 from US$1.1024
Dollar/yen: UP at 108.79 yen from 108.39 yen
London - FTSE 100: FLAT at 7,211.64 points (close)
Paris - CAC 40: UP 1.0 per cent at 5,702.05 (close)
Frankfurt - DAX 30: UP 1.2 per cent at 12,629.79 (close)
EURO STOXX 50: UP 1.2 per cent at 3,598.65
Tokyo - Nikkei 225: UP 1.9 per cent at 22,207.21 (close)
Hong Kong - Hang Seng: DOWN 0.1 per cent at 26,503.93 (close)
Shanghai - Composite: DOWN 0.6 per cent at 2,991.05 (close)
Brent North Sea crude: DOWN 0.2 per cent at US$59.24 per barrel
West Texas Intermediate: DOWN 0.4 per cent at US$53.41 per barrel