LONDON Sterling struck multi-month highs on Thursday, adding to its biggest monthly gains against the euro since 2009, after Britain's Brexit minister said the government would consider paying into the EU budget for market access.
The pound recovered from an initial dip after weaker-than-expected data to add over 1 percent in trade-weighted terms on the day.
Britain is formulating its negotiating position ahead of formal divorce talks next year, and businesses want reassurance that it won't seek a "hard Brexit" that would prioritise curbing immigration over remaining in the EU single market.
Asked on Thursday by a lawmaker if the government would consider making "any contribution in any shape or form" for access to the EU's single market, David Davis said it would.
Sterling, coming off the back of its best month against the dollar since March, hit a two-month high against the greenback after Davis's comments and broad dollar weakness caused by data showing U.S. jobless claims at a five-month high.
"These headlines suggesting Britain may be able to access the single market are generating substantial sterling demand from traders and investors looking to reduce their short positions and unwind hedges," said Neil Jones, head of FX hedge fund sales at Mizuho.
Investors have been steadily reducing record short positions on the currency put on after the Brexit vote in June.
Sterling, which fell below $1.20 in a flash crash at the start of October, rose to a two-month high against the dollar at $1.2696, and a three-month peak against the euro at 83.69 pence per euro.
It eased back slightly as the day wore on but booked its biggest daily rise against the Bank of England's trade-weighted broader measure for the currency since early November, closing at 78.8.
Davis's comments chimed with hints from British Prime Minister Theresa May earlier this month that she could be open to some form of transitional agreement with the EU, easing fears about the disruptions Brexit may bring.
"I've always thought that the EU budget was the one place where there wasn't a red line. That was always the place where there was the potential for some leeway," said Derek Halpenny, head of global market research at Japanese financial group MUFG.
"For a minute, the hard Brexiteers thought they were going to get it all their own way. That now does not seem to be the case."
A number of major banks have called for the pound to fall to around $1.15 or lower in the first months of 2017 as Britain triggers Article 50 procedures that start a two-year countdown to its EU exit.
Disappointing British manufacturing data on Thursday gave a glimmer of the economic hit Brexit could bring. Factory output cooled unexpectedly in November as manufacturers grappled with soaring costs caused by sterling's slump, while the weaker pound failed to boost export orders as much as in previous months.
(Additional reporting by Jamie McGeever and Patrick Graham; Editing by Catherine Evans and Richard Lough)