LONDON: Sterling edged lower on Tuesday erasing earlier gains as the US dollar moved briefly higher, while fears of a second wave of virus infections and a Bank of England policy meeting later this week capped the pound's advance.
The move lower reversed a trend earlier in the session where the pound had been advancing towards a five-month high hit last week versus the dollar. Sterling fell 0.27% to $1.3043 against the dollar and rose 0.13% against the euro to 90.10pence.
The pound's recovery has been impressive in the past few weeks. It registered its biggest monthly rise in more than a decade in July even though prospects of a breakthrough in Brexit negotiations with Europe before a December deadline remain elusive.
"I believe that the key point to consider is that sterling has had a big rally over the past few days," said Francesco Pesole at ING. "The trigger might be the virus situation in the UK that is looking once again quite worrying in the sense that we are hearing about the possibility of the UK government reimposing economic restrictions. The economic outlook for the UK is already quite grave and this would naturally add to that."
A second wave of the pandemic could be twice as bad as the initial outbreak in Britain, a new study claimed on Tuesday. Short positions in the pound have reduced recently as sentiment has improved and traders shifted their negative outlook to the US dollar, Morgan Stanley said in a note.
But the pound faces headwinds from domestic factors as well as global forces. British Prime Minister Boris Johnson said last week he would postpone the next stage of lockdown easing for at least two weeks due to a pick-up in Covid-19 infection rates.
"I think it's more a case of the dollar giving back some of the gains we've seen over the last couple of trading sessions," said Lee Hardman, a currency strategist at MUFG in London. "That downward pressure on the dollar is resuming partly because of the (Federal Reserve Bank's) response to the coronavirus." Signs that dollar weakness have been the major driver of pound gains can be seen from the performance of the British currency versus the euro and the Japanese yen.
While it has strengthened nearly 15% versus the US currency since the March lows, it has risen less than 6% against the euro and less than 12% versus the yen in the same period. Investors are awaiting the Bank of England's policy meeting on Thursday where money markets are already pricing in the prospects of negative interest rates by early next year.
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