By Elizabeth Howcroft
LONDON (Reuters) - The pound rose above $1.26 on Monday and recovered from an early-morning 20-day low against the stronger euro, but investors remained bearish as Britain's bleak economic outlook and Brexit risks weighed on the currency.
Since Friday, European Union leaders have been meeting to thrash out plans for an EU-wide coronavirus recovery fund. Signs of progress in negotiations saw the euro touch a 19-week high, pushing euro-sterling to a 20-day high around 0604 GMT.
With a new round of Brexit negotiations between Britain and the EU beginning on Tuesday, hopes for a trade deal in time for the year-end expiry of the transition period following Britain's departure from the bloc are fading fast.
"There will be a deal but it will be a hard Brexit, probably worse than a Canada deal," said Kaspar Hense, a portfolio manager at Bluebay Asset Management.
Hense is bearish on the pound versus both dollar and euro but took some profit on his short cable position at $1.25 on Friday because he said EU leaders reaching an agreement could boost euro-dollar, to which cable is correlated.
"The growth outlook looks pretty bad. London is in focus as well as the (Brexit) deal probably will be rather harsh especially on the services side," he said.
"These growth detractions are not going away," he said, adding that, from a structural perspective, the pound-dollar exchange rate could slide to parity over the longer term.
Versus the dollar, sterling changed hands at $1.2637 at 1415 GMT, up 0.6% since New York's close, having fallen overnight then recovered gradually from around 0400 GMT <GBP=D3>.
Against the euro, the pound was at 90.375 pence per euro - similar levels to last Monday's close - having gained around 0.6% on the day as investors took profits on the euro <EURGBP=D3>.
The speculative market's net short position on the pound got smaller from a second week in a row in the week to July 14, according to CFTC futures data. But the market is still as bearish on the pound as it was in December 2019. [1096742NNET]
Tensions between China and Britain escalated over the weekend.
British drugmaker AstraZeneca's <AZN.L> experimental COVID-19 vaccine was safe and produced an immune response in early-stage clinical trials at Britain's University of Oxford, data on Monday showed.
Britain's COVID-19 death toll is the highest in Europe, but the country has begun to lift lockdown measures as case numbers and infection rates fall.
Nearly half of Britain's biggest companies think it will take until the second half of 2021 before business recovers from the coronavirus pandemic.
(Reporting by Elizabeth Howcroft; Editing by Angus MacSwan)