LONDON: Sterling fell back to around $1.24 on Tuesday, with illiquid trading conditions helping the pound reverse around half of a 1 percent rise the previous day on the view that Brexit will be slower - and softer - than had been feared.
The pound jumped above $1.25 on Monday after Prime Minister Theresa May pledged to address business concerns that Britain could fall off a "cliff edge" into uncertainty when it leaves the European Union, hinting at some form of a transitional agreement.
But having initially built on those gains on Tuesday, touching a one-week high of $1.2514 in Asian trade, sterling slid steadily throughout Tuesday, trading at $1.2404 by 1535 GMT, down 0.7 percent on the day.
Analysts said sterling's current volatility was the result of thin liquidity and stretched positions against the pound, rather than any fundamental drivers.
"Positioning will mean you get the odd bit of volatile price action - liquidity in the sterling/dollar pair is very thin compared with normal," HSBC currency strategist Dominic Bunning said. "Financial investors ... are just not as active in the market and don't want to be involved in sterling because of the political risk - they just almost think it's not worth it."
May's speech on Monday was the strongest signal yet that she might be open to a deal that would offer Britain time to forge a new trading relationship with the EU when formal divorce talks are concluded, probably in 2019.
"If the government were to stick to a two-year deadline that would be unlikely to result in any kind of agreement, so that would be likely to lead to a really hard Brexit, so this transitional arrangement is positive," said Societe Generale currency strategist Alvin Tan.
"If the final agreement takes five years, as some are saying, or even seven years, like the Canada-EU trade agreement, then the transitional arrangement is what markets are going to be focused on.
Five to seven years is further than most people's horizons when it comes to financial markets."
Against the euro, sterling edged down 0.2 percent to 85.31 pence, after trading below 85 pence on Monday - its strongest level in two months.
Sterling was little moved by data showing Britain ran a much smaller than expected budget deficit in October. Public finances still looked weak for the year as whole.
The market's focus will now switch to Wednesday's budget update from the British government.
Finance minister Philip Hammond on Sunday played down the chances of a major new boost for spending in the autumn statement - his first in his role as head of the Treasury.
Analysts expect some modest infrastructure spending and housing stimulus on Wednesday but nothing that would radically change expectations of a weaker economy next year when difficult talks begin on the terms of Brexit.
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