The pound rallied Tuesday after the European Union's top Brexit negotiator flagged the possibility of a divorce deal this week, reviving hopes Britain could avoid crashing out of the bloc.
With the exit deadline on October 31, Michel Barnier's comments reinforced hopes for an eventual agreement between the two sides and came after reports said a compromise was taking shape.
Ahead of a meeting to update EU countries on negotiations, he 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."
Sterling surged more than one percent to as high as $1.2698, near levels not seen since June, before easing slightly. It also picked up against the euro.
The currency had already been rising after Britain's Daily Telegraph 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 is 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".
He added in a note: "While it is by no means certain that the UK and Europe can agree to a deal or that such a deal can make it through the UK parliament, there does appear to be recognition from the British side that any Brexit deal will have to treat Northern Ireland very differently from the rest of the UK."
Barnier's remarks also boosted the FTSE in London, which rose 0.1 percent in early business. Paris gained 0.7 percent and Frankfurt climbed 0.5 percent.
Trade deal worries
Asian equity markets were mixed as investor caution returned, replacing the optimism fanned by Donald Trump's much-vaunted 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.
Equity traders, who have been under pressure from the trade war as well as the slowing global economy and worries about Brexit among others, seized on Friday's announcement and sent regional markets surging Monday.
But they struggled to build on that as questions swirled over the value of the deal.
"It has taken precisely one working day of the new week for optimism to fade about the US-China trade deal lite/mini/part one," said Jeffrey Halley, senior market analyst for Asia-Pacific at OANDA.
"The rhetoric-high, but detail-light trade announcement in Washington DC on Friday has been tempered by China being both a lot more circumspect and requesting additional talks before signing an agreement."
He said that while he expected the two to hammer out something for Trump and counterpart Xi Jinping to sign before they are due to meet next month, "the pseudo-deal itself represents nothing more than a holding action".
Still, US Treasury Secretary Steven Mnuchin said on Monday that officials would hold further talks by phone this week and the next to finalise the deal.
He also defended it on CNBC.
"There is a fundamental agreement in principle," he said. "There are still some issues that need to be worked out in wording but I would say we have every expectation that phase one will close."
Hong Kong slipped 0.1 percent and Shanghai ended down 0.6 percent, while Singapore, Bangkok and Manila were also in the red.
But Tokyo jumped 1.9 percent as dealers returned from a long weekend to play catch-up with the rest of Asia.
Sydney added 0.1 percent, Seoul was flat and Taipei put on 0.4 percent. Wellington, Mumbai and Jakarta were also higher.
Key figures around 0810 GMT
Pound/dollar: UP at $1.2667 from $1.2555 at 2040 GMT
Euro/pound: DOWN at 87.05 pence from 87.79 pence
Euro/dollar: UP at $1.1024 from $1.1024
Dollar/yen: DOWN at 108.37 yen from 108.39 yen
London - FTSE 100: UP 0.1 percent at 7,218.58
Tokyo - Nikkei 225: UP 1.9 percent at 22,207.21 (close)
Hong Kong - Hang Seng: DOWN 0.1 percent at 26,503.93 (close)
Shanghai - Composite: DOWN 0.6 percent at 2,991.05 (close)
West Texas Intermediate: DOWN 39 cents at $53.20 per barrel
Brent North Sea crude: DOWN 36 cents at $58.99 per barrel
New York - Dow: DOWN 0.1 percent at 26,787.36 (close)
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