By Harry Robertson
LONDON (Reuters) -Sterling regained ground against the dollar in volatile trading on Wednesday after the Bank of England (BOE) said it would step in to calm the turbulence in the UK government bond market.
The pound fell as much as 1.74% after the BOE's announcement but clawed its way back into the green to stand 0.2% higher at $1.0737 in late London trading.
The euro was up 0.4% against the pound at 89.71 pence after paring earlier gains.
UK assets have tumbled in recent days after new Finance Minister Kwasi Kwarteng on Friday announced a swathe of tax cuts to be funded by borrowing. The pound, which is down more than 20% this year, dropped to a record low of $1.0327 on Monday.
Stress has been most apparent in government bond markets, where prices have tumbled and yields have surged.
The BOE decided it had to step in on Wednesday, saying it had seen "dysfunction" in the market for long-dated gilts and that it would buy up to 65 billion pounds worth of assets to rectify the situation.
Bond prices rallied sharply, with the yield on the benchmark 30-year gilt falling more than a percentage point.
Chris Turner, head of markets at ING, said a delayed positive reaction to the BOE's intervention may have boosted the pound.
"Given that the sell-off in gilts since early August had been a big factor driving sterling weakness, today’s intervention will be welcomed by some," he said.
The pound was aided by a reversal in the dollar on Wednesday, as US bond yields fell sharply along with those in the UK.
{{2126|The dodollar index was last down 0.42%. That undid earlier gains which had seen the currency hit new 20-year highs.
Despite the recovery in the pound, Turner said many investors will remain pessimistic and trading will stay febrile. The BOE's move "effectively provides room for the government to continue with its aggressive fiscal programme", he said.
The International Monetary Fund on Tuesday released a statement saying "we do not recommend large and untargeted fiscal packages" at the same time as monetary policy is being used to tackle high inflation. It suggested the UK government "reevaluate" its plans.
Ratings agency Moody's also weighed in on Tuesday, saying the unfunded tax cuts were "credit negative" and likely to weigh on growth.
Strategists at Barclays (LON:BARC) cautioned that any respite for the pound might not last long, with storm clouds still hanging over the UK economy.
"The currency is likely to be the easiest 'release valve' as investors come to terms with recent policy actions," they said in a note to clients on Wednesday.