LONDON - Sterling fell as much as 1% on Thursday before cutting losses and turning positive as the dollar wavered and British Prime Minister Liz Truss defended the government's economic plans.
Truss said big tax cuts were the right path for Britain and refused to consider reversing the so-called "mini budget" laid out last week, which triggered chaos in markets.
The pound was last up 0.7% to $1.09660 after rebounding from a session low of $1.0764. The euro was down 0.73% against sterling at 88.81 pence.
Adam Cole, head of foreign exchange strategy at RBC Capital Markets, said the driver in the market was the dollar, which picked up in Asian trading but later fell back.
The dollar index was last down 0.3% to 112.65. It had earlier risen as much as 0.67% to a session high of 113.79.
Analysts said the dollar's pull-back came after the People's Bank of China told state banks to be prepared to sell the U.S. currency in favour of the yuan, which was first reported by Reuters.
Sterling crashed to a record low against the dollar of $1.0327 on Monday after new finance minister Kwasi Kwarteng unveiled plans to cut taxes, particularly for the rich, and raise borrowing.
The mini budget also wreaked havoc in the UK government bond market, forcing the Bank of England (BoE) to intervene on Wednesday to protect pension funds, which are big holders of long-dated gilts.
The BoE said it would buy around 65 billion pounds ($71 billion) of long-dated government bonds to rectify "dysfunction" in the market.
Sterling bounced 1.41% on Wednesday to close at $1.0877 as investors digested the BoE's plans. But the currency resumed its long-running slide early Thursday as Truss came out to defend her government's policies. It has tumbled 20% so far this year.
"We are facing difficult economic times," she said on local BBC radio. "I don't deny this. This is a global problem. But what is absolutely right is the UK government has stepped in and acted at this difficult time."
Jonas Goltermann, senior markets economist at consultancy Capital Economics, said both dollar strength and fears about the British economy were weighing on the pound.
"I don't think (the BoE's intervention) is going to be a long-term boost for sterling, although it might prevent an extreme downturn," he said.
Goltermann said further falls in sterling were probable. He said traders were expecting the BoE to hike interest rates above 6%, but were likely to be underwhelmed.
One analyst said they were also watching for signs of more selling of UK assets by pensions funds.
Pensions funds have been heavily selling gilts in recent days after the market falls triggered calls for collateral payments on their gilt derivatives positions, analysts and pensions advisers said.
Many analysts said they remained pessimistic about the pound, given the direction of the dollar and the economic storm clouds over the UK.
"There is no confidence in the Truss government right now. The problem is not fiscal spending per se, the problem is that people just don't trust what she is doing," Ipek Ozkardeskaya, senior analyst at Swissquote, said.
Cole said RBC Capital Markets had long expected the pound to fall to $1.04, but would likely cut its price target even further in the coming days.
(Reporting by Harry Robertson, Carolyn Cohn and Bansari Mayur Kamdar; Editing by Jane Merriman and Mark Potter)