Sterling on Tuesday clung to hopes that a Brexit trade deal is still possible with British Prime Minister Boris Johnson set to meet European Commission President Ursula von der Leyen in Brussels.
With only three weeks to the end of the Brexit transition period, leaders have failed again to narrow their outstanding differences on a future trading relationship.
However, sterling recouped most of the previous session’s sharp drop after the announcement of the meeting in Brussels.
Versus the dollar, the pound was down 0.3% at $1.3346 at 0935 GMT, after touching an almost three-week low of $1.3225 on Monday.
Against the euro, sterling was 0.4% lower at 90.88 pence, after falling to a seven-week low on Monday.
One-week implied volatility for the pound hit a eight-month high. The premium of pound puts to calls is also elevated, as traders hedge against a no-deal outcome, although it has tempered slightly since Monday.
Traders seemed hopeful that face-to-face meetings between UK and EU leaders can break the deadlock.
“GBP has stabilised after the initial sell-off yesterday and pared most of its losses as PM Johnson and EC President von der Leyen agreed to meet in Brussels this week,” said Chris Turner, global head of markets at ING.
“We think a UK-EU trade deal narrowly remains the most likely outcome of talks, which should lead to an eventual but modest GBP rebound,” ING said in a note to clients.
Johnson said on Tuesday that Brexit talks were “very tricky” and there might come a moment when London would have to acknowledge that it was time to go for a no-deal Brexit and abandon talks.
UBS strategists said progress could still be made over the next few days and a compromise deal would likely offer sterling a short-term lift. But in a note to clients they also said that over the next few months, the bank does not expect “a material rise above $1.35 or for EURGBP to fall below 0.88”.
Additional reporting by Ritvik Carvalho; Editing by Kirsten Donovan