Sterling rose against a weaker dollar on Thursday on hopes of a Brexit deal, but concern among investors about the Ireland border issue kept gains in check. Hopes are building that a trade deal between the European Union and Britain can be struck before an EU summit on October 18.
The pound has risen for three consecutive days and was buoyed by comments on Wednesday from the EU's Brexit negotiator Michel Barnier suggesting a deal next week was imminent. Sterling rose 0.3 percent to $1.3250, nearing a three-month high of $1.3295. At 1330 GMT, it was 0.2 percent down versus a resurgent euro at 87.41 pence.
Doubts over whether the fraught issue of EU checks on goods entering Northern Ireland can be overcome remains, and that is stopping some traders from unwinding their short bets on the currency. "Though investors believe that 80 percent of the work on the Brexit deal framework may be over, it is the last 20 percent that is the most difficult," said Thomas Flury, head of currency strategy at UBS Global Wealth Management's Chief Investment Office in Zurich.
"We have a short pound position against the dollar around $1.31 as we believe there is more political uncertainty in store," he said. The EU's Barnier says Britain must accept possible checks on goods moving between its main island and its province of Northern Ireland.
But the Northern Irish party that British Prime Minister Theresa May's government relies on for support has threatened to challenge her leadership if their wishes aren't respected on the Irish border. "Building optimism over a potential breakthrough in Brexit talks at next week's summit is continuing to encourage pound outperformance," said analysts at MUFG.
The analysts said that if a no-deal exit from the bloc was avoided the currency could strengthen another 5 to 10 percent in the coming months. May will brief her cabinet on the progress of Brexit negotiations on Tuesday before she heads to Brussels for the EU summit.
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