Sterling rebounded on Monday as investors who had sold the currency for safe havens after the United States killed Iran's top military commander returned to the pound.
Analysts said an upward revision to a business survey supported the pound too while the focus for investors now shifts to a parliamentary debate on Brexit legislation on Tuesday.
"We've got some better than expected PMIs, but some of it (the move higher in sterling) has been sentiment-driven," said Morten Lund, an analyst at Nordea. "It's a bit surprising, but I think some of it is positioning."
The Purchasing Managers Index survey for Britain's services for December came in with a final reading of 50, better than the 49.1 reading forecast by economists polled by Reuters.
Optimism among companies has improved markedly since the Dec. 12 election, although the economy continues to stagnate, the PMI survey showed.
Investors have remained cautious about the pound since Prime Minister Boris Johnson's Conservatives won a big majority in the vote. They worry about more political uncertainty down the road with Britain set to leave the European Union on Jan. 31 and the two sides then beginning negotiations on their future trading relationship.
RBC Capital Markets currency strategist Adam Cole noted that provisional January PMIs on Jan. 24 "will be more interesting as they will shed some light on the potential for a rebound in activity early in 2020 as political uncertainty cleared following the election."
The UK parliament returns on Tuesday and will debate the Brexit bill, which includes a clause ruling out any extension of the transition period for trade talks beyond December 2020.
The pound rose 0.7% to as high as $1.3173 on Monday but remains below last week's $1.32.
Sterling fell on Friday after the killing of Iranian general Qassem Soleimani in a US drone strike at Baghdad airport, boosting demand for safe-haven currencies, including the dollar.
The pound gained 0.4% to 85 pence before settling at 85.105 pence. It remains some way off its more than three-year high of 82.78 pence per euro reached last month.
Some analysts think sterling is in for a drop.
Danske Bank analysts see the pound falling to around 87 pence per euro in three months because the Bank of England will soon cut interest rates by 25 basis points due to economic weakness.
"Our base case is that this happens in January, but since the BoE has hinted it may want a bit more post-election data to rely on, the cut may not come before the May meeting," the analysts said in a note. They said investors were not pricing in more than a 50% probability of a cut by the end of 2020.
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