Sterling erased earlier losses and headed back towards the day's highs in volatile trading.

The optimism was fuelled by growing hopes of a Brexit deal breakthrough after a cabinet meeting.

British Brexit Secretary Dominic Raab said "Thumbs Up" on his way out of a weekly cabinet meeting, according to a tweet by the BBC political editor, sending the euro to a five-month low against the British pound.

"We are coming to a stage where the markets believe that a deal may be on the cards and sentiment is not that negative towards sterling as it was a few weeks ago," said Manuel Oliveri, an FX strategist at Credit Agricole in London.

Against the dollar, the pound hit a two-week high.

While hopes have grown of a deal covering Britain's exit from the European Union, fuelling a 3% rally in the British pound over the last week, domestic opposition from within Prime Minister Theresa May's own Conservative party and parliament has made investors wary of betting big on the pound.

A senior member of the Northern Irish Democratic Unionist Party earlier said it looked like Britain would exit the EU without a deal, indicating domestic political headwinds togetting a deal through a split parliament with less than five months to go to Brexit day.

Headlines on the progress of Brexit negotiations have made the pound increasingly jumpy. Implied volatility on one-month pound options, a gauge for expected swings in the British currency, is at its highest levels since February.

Northern Ireland's DUP, which May's minority government relies on to get legislation through parliament, has vowed to scupper any Brexit deal that treats the province differently from the rest of the United Kingdom.

Some unwinding of short positions has also helped sterling. 

While net shorts have shrunk slightly from more than two-year highs in September, they remain near historical highs.