Sterling jumped to an eight-day high after the head of a group of euro sceptic lawmakers in Prime Minister Boris Johnson's Conservative Party said the government's latest Brexit proposals offered the possibility of a "tolerable deal".
A weaker dollar on a weaker-than-expected US non-manufacturing purchasing managers' index inflated the rise, sending the pound above $1.24.
"There does seem to be maybe some reason to be optimistic in terms of the Brexit plan," said Jane Foley, senior forex strategist at Rabobank.
"We know this is not a done deal, but it hasn't yet been written off" and this is what is exciting market participants at the moment, Foley said.
By 1430 GMT sterling was up 0.9% at $1.2410, an eight-day high. Against the euro, the pound was up 0.6% at 88.64 pence.
Traders remained unsure whether Johnson's proposal to replace the Irish border "backstop" was going to morph into a final Brexit divorce agreement due to mixed messages coming from both sides.
"For sterling, as it's often the case these days, the outlook is binary," said Foley.
The so-called backstop is an insurance policy to prevent the return of a hard border on the island of Ireland, which has become the biggest hurdle to securing an agreement with Brussels.
The British government on Wednesday proposed an all-island regulatory zone in Ireland to cover all goods, replacing the so-called backstop arrangement, and was waiting for an official response from its European counterparts.
But a European Parliament Brexit group believes the new proposals "do not represent a basis for an agreement", according to the draft of a statement seen by Reuters ahead of release later in the day. A senior European Union official said on Thursday that Johnson's last-ditch Brexit proposal "can't fly".
Analysts say the market is largely sceptical that the EU will agree to Britain's latest offer to avoid a no-deal departure from the European Union on October 31. But with hedge funds covering some of their short bets against the pound, the currency has held at current levels.
Just 28 days before the United Kingdom is due to leave the EU, both sides are positioning themselves for a delay or a disorderly no-deal Brexit. Johnson says he wants a deal but insists there can be no delay beyond the end of the month.
The cool reception from Brussels to Johnson's proposal indicates just how far apart the two sides are on the first departure of a sovereign state from the EU, which was forged from Europe's ruins after World War Two.
"It would be one monumental climb-down by the EU to go from a customs union backstop for either the whole of the UK or Northern Ireland with no time limit to a plan that does not entail a customs union and requires some form of border checks that has a potential rolling four-year time-limit attached," MUFG analysts said in a note.
"But for now, the hope of some breakthrough may continue to provide GBP support, but we don't see it lasting... We see building risks to the downside and expect the September lows to be tested pretty quickly in the coming days/weeks," they said, referring to the $1.1959 three-year low hit in early September.