LONDON: Sterling held on to gains made against the dollar and the euro on Monday after Britain and the European Union extended discussions on a post-Brexit trade deal beyond the previous day's deadline.
The EU's Brexit negotiator, Michel Barnier, said a new pact with Britain was still possible as negotiators sought to break deadlocks on access to fishing waters for EU vessels and corporate economic fair-play rules.
By 1610 GMT, the pound traded 0.9% higher to the dollar at $1.3338, having risen as much as 1.6% to $1.3444 earlier.
Against the euro, it was 0.7% higher at 90.94 pence per euro.
"The pound is obviously relieved that the trade talks will continue between the EU and the UK," said Jane Foley, head of FX strategy at Rabobank.
"However, no tangible process has been confirmed over the weekend and the market is therefore likely to remain on tenterhooks in the week ahead. Without confirmation that progress has been made, the pound's gains are likely to be capped."
The odds of Britain agreeing a trade deal with the EU before the end of a transition period have risen to 57% on Monday, up from 40% last week, according to punters betting on the Smarkets exchange. Chances of no deal had risen to as much as 61% on Friday from 19% in late November, according to the exchange.
Odds of no-deal on bookmaker Betfair had receded to 38% on Monday, down from 58% the previous day.
Investors also appeared cautiously optimistic on the chances of a deal, particularly as the end of the Brexit transition period on Dec. 31st draws closer.
"In our view, a deal is still more likely than not, but with each day that passes, the risk of a no-deal outcome grows," said Mark Haefele, chief investment officer at UBS Global Wealth Management.
UBS added that the announcement of an agreement could push sterling to $1.35, while increasing uncertainty about a no-deal outcome could lead it to revisit September lows around $1.28.
ING's currency strategists said they expected a pound rally to materialize in the next two weeks, with a deal still being the most likely scenario. Still, they warned of more downside risk to the currency as it was pricing in a "good probability of a deal."
CFTC positioning data showed that speculators flipped to a net long position on the pound in the week up to last Tuesday.
Goldman Sachs said it expected sterling to appreciate by 1.5-2% against the euro on apparent progress towards a deal or "at least avoiding a no deal outcome for now."
Economists at Citi said that even if a deal is agreed over the coming days, "persistent acrimony remains likely", which would weigh on the medium-term outlook. They said a Canada-style deal with the EU is now the best possible outcome.
Jeffrey Sacks, head of EMEA investment strategy at Citi Private Bank suggests buying into the pound on any weakness as he sees further upside in the currency if there is a deal. He expects the pound to hit $1.37 over the next 6-12 months.
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