By Ritvik Carvalho

LONDON (Reuters) – Sterling pulled away from a one-week low against the dollar on Tuesday and also gained ground against the euro as rebounding risk appetite in broader asset markets weakened the U.S. currency.

The pound fell in early trade after risk sentiment ebbed overnight in U.S. and Asian markets.

However, sentiment turned around as European stock markets bounced and U.S. stocks hit record highs on strong corporate earnings, pushing the dollar back down and boosting riskier currencies. [.EU] [.N]

Expectations of a large U.S. fiscal stimulus package has fuelled risk sentiment in markets in recent weeks, benefiting the pound, which has hit 2-1/2 year highs against a weakened dollar.

Sterling also hit its highest against the euro since May 2020 last week, with analysts attributing the pound’s gains to a slower COVID-19 vaccine rollout in the European Union than in Britain.

By 1452 GMT, sterling was up 0.3% against the dollar at $1.3720 and was also up 0.3% against the euro, at 88.60 pence. It earlier fell to $1.3610 against the dollar, its lowest in a week.

“It’s a function of the broader risk dynamic so I think sterling is still trading rather more on risk orientation than it is the domestic fundamental story,” said Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets, adding that the market was not overtly concerned with data showing a rise in UK unemployment.

Data on Tuesday showed Britain’s unemployment rate hit its highest in nearly five years in the three months to November when coronavirus cases began to rise for a second time and most of the country returned to a partial lockdown.

Redundancies touched a record high, taking the unemployment rate to 5.0%, its highest since mid-2016, according to official data, although the increase was slightly weaker than economists’ forecasts.

Graphic: UK unemployment rate hits highest since 2016, https://fingfx.thomsonreuters.com/gfx/mkt/jbyvrneawve/Pasted%20image%201611657086682.png

“The UK labour market report did not provide any negative surprise this morning (November unemployment was modestly lower vs expectations, while weekly earnings turned higher), suggesting a day of calm for sterling today,” ING said in a note. “Euro-sterling to range trade around the 89 pence level.”

(Reporting by Ritvik Carvalho; editing by Emelia Sithole-Matarise and Susan Fenton)