The euro and sterling rose on Tuesday as Britain and the EU agreed on a preliminary text for the UK to leave the economic bloc in a bid to avoid a chaotic divorce that would disrupt the region’s economy.
The stronger euro and sterling spurred profit-taking in the dollar, which reached a 16-month peak against a basket of currencies on Monday.
Uncertainty over the terms of Brexit has bogged down both the euro and sterling because a deal is needed to keep business open between the EU and Britain.
"There's some cautious optimism, but there is some scepticism," said Erik Nelson, currency strategist at Wells Fargo Securities in New York.
It is unclear whether British prime minister Theresa May can get the deal approved by parliament, where hardline Brexit supporters accused her of surrendering to the EU. Ms May's cabinet will meet on Wednesday on the Brexit draft.
Sterling hit a 6½-month peak versus the euro on the perceived progress toward a Brexit agreement. Sterling also reversed much of its loss on Monday against the dollar.
The euro was up 0.34 per cent at $1.12570 in early afternoon trading in the US. It fell to $1.1216 on Monday, the lowest level since June 2017.
The euro’s gain was limited by concerns about Italy’s budget proposals and downbeat German investor sentiment data, traders said. Against the pound, the common currency was down 0.48 per cent at 86.885 pence. Earlier on Tuesday it touched 86.82 pence, which was the lowest level since April 26th.
Italy’s budget proposals
Against the dollar, sterling was up 0.82 per cent at $1.2955 following a nearly 1 per cent drop on Monday. The index that tracks the dollar versus the euro, sterling, yen and three other currencies was 0.15 per cent lower at 97.397, easing below a 16-month high of 97.693 reached on Monday.
In contrast to the latest news on Brexit, Italy's budget proposals remain a drag on the euro. Tuesday was the deadline for Italy, the euro zone's third biggest economy, to resubmit its 2019 budget plans to the EU.
The European Commission rejected Italy's plan last month, and has threatened to impose penalties if it is not revised to conform with EU regulations – something Rome has indicated it is unwilling to do.
The International Monetary Fund on Tuesday warned that the government's stimulus plan would leave Italy vulnerable to higher interest rates that could ultimately plunge it into recession. The tension between Rome and Brussels has raised fears about Italy's membership in the euro zone.
"Italy is the big test case for the euro," said Joachim Fels, global economic adviser at Pimco, at the Reuters Global Investment Outlook Summit in New York. "That risk is not going away anytime soon." – Reuters