Sterling dipped against the dollar on Tuesday after the UK Treasury announced a major shake-up of British banks and investors braced for a possible extension of asset purchases by the Bank of England this week. The pound rose against a broadly weaker euro, however, and pared some of its earlier losses against the dollar on speculation of sterling-positive M&A activity.
Some traders said speculation Kraft Foods Inc could announce a fresh offer for Cadbury with its earnings report later on Tuesday supported the currency. Trading was highly jittery, ahead of the BoE meeting which concludes on Thursday.
Investors also digested the potential implications of the banking shake-up, under which Royal Bank of Scotland and Lloyds Banking Group are to get another 31 billion pounds from the government and have agreed to sell key businesses. The shake-up highlights the fragility of the financial sector, which is a key part of the UK economy, and will add to concerns about the country's public finances.
"After the banking announcement the knee-jerk reaction was to sell sterling, but the fact that it has come back again may reflect a reassessment that perhaps there is nothing particularly surprising in all this," said ING currency strategist Tom Levinson.
At 1636 GMT, sterling was down 0.1 percent against the dollar at $1.6382, having hit a one-week low of $1.6260. Kraft results were due after the US market close. The pound reversed earlier falls against the euro to post solid gains, with the single currency falling by 0.8 percent to 89.34 pence.