LONDON- Sterling edged lower on Tuesday erasing earlier gains as the U.S. 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 0.3% to $1.3039 against the dollar GBP=D3 and weakened 0.4% against the euro to 90.32 pence EURGBP=D3 .
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.
Short positions in the pound have reduced recently as sentiment has improved and traders shifted their negative outlook to the U.S. 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 U.S. 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.
In the United States, Democrats in the U.S. Congress and White House negotiators are in talks on a new coronavirus relief bill after a deadline was missed on Friday to extend enhanced unemployment payments during the pandemic.
Any delay in unveiling more stimulus measures would fuel another round of selling in risky assets and drag the pound lower.
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.
(Reporting by Maiya Keidan and Saikat Chatterjee. Editing by Carmel Crimmins and Jane Merriman) ((Maiya.Keidan@thomsonreuters.com; 44 207 542 1594; Reuters Messaging: email@example.com))