Sterling rallied on Monday after the EU and UK decided to “go the extra mile” and continue Brexit trade negotiations.

The pound climbed as much as 1.7 per cent against the dollar to $1.3445, before trimming its gain to around 0.8 per cent in afternoon dealings in London. It advanced 0.5 per cent against the euro to €1.0966.

Monday’s gains partly reversed last week’s 1.6 per cent fall, which was triggered by warnings from EU and UK leaders that Britain could leave the bloc without a trade deal when the Brexit transition period concludes at the end of this year. The pound had reached a high of $1.3539 in early December.

UK government bonds, considered a haven asset, came under pressure as debt investors joined currency traders in their more optimistic outlook. Yields on 10-year gilts, which move in the opposite direction of prices, were up 0.05 percentage points to 0.22 per cent.

Boris Johnson, UK prime minister, and Ursula von der Leyen, European Commission president, agreed in a “constructive” call on Sunday to “go the extra mile” in an attempt to break the deadlock, as both sides reported progress. Still, no deadline was set for negotiations and British officials admitted they could drag on until Christmas.

Lee Hardman, currency analyst at MUFG, said the “latest developments have supported the assumption . . . that a last-minute trade deal would be reached, but the risks remain high that efforts to reach a deal could still fail posing significant downside risks for the pound”.

Line chart of  showing Pound rises on renewed hopes for Brexit deal

Barclays analysts echoed that view, saying negative risks to the pound would persist until negotiators reach an agreement. If the EU and UK make a deal, the currency could trade above $1.35, the bank said. In the case of a no-deal outcome, Barclays expected the pound to drop to about $1.25.

“A deal narrowly remains our base case and . . . we expect the pound to bounce ultimately,” strategists at the UK bank said.

Gregory Perdon, co-chief investment officer at Arbuthnot Latham, said he had “second thoughts” late last week about his bet that sterling would rise. However, he decided to stick to his “conviction” since “both parties are probably better off economically with a deal”.

“Let’s hope rationality wins in this instance,” he said.

Sterling’s gains on Monday come ahead of Thursday’s Bank of England meeting. Economists broadly expect the UK central bank to hold steady on policy after it boosted its bond-buying programme by £150bn at its November meeting.

Column chart of  showing Sterling on track for best day since October

Bank of America said Brexit news remained the potential near-term catalyst for a change at the UK central bank and “if markets became jittery the BoE could increase the QE purchase pace at short notice”.

Measures of expected volatility in sterling over the next month remain elevated, signalling heightened market expectations for big swings in the pound as 2020 nears its end.

“An EU trade agreement was never going to be all-encompassing and therefore definitive for the UK’s economic future,” said David Bailin, chief investment officer at Citi Private Bank. “The pound could still move sharply on a deal or no-deal event, with all the action coming fast and unpredictably.”