LONDON (Reuters) - With three weeks to go before Britain is due to exit the European Union, interest in selling the pound against the dollar and euro is dwindling as currency traders bet that the worst-case scenario of a no-deal Brexit will be averted.

FILE PHOTO: Dealers work at their desks whilst screens show market data following a vote on Prime Minister Theresa May's Brexit 'plan B' at CMC Markets in London, Britain, January 30, 2019. REUTERS/Dylan Martinez//File Photo

Overall positioning still implies a degree of caution about the outcome. But with parliament expected to extend the date of Brexit beyond March 29 rather than let Britain crash out of the EU without a transition period to minimise economic disruption, the pound has surged to multi-month highs in recent weeks.

It is up 7 percent against the dollar year-to-date, making it the world’s best performing major currency.

Various positioning gauges meanwhile indicate that selling sterling in anticipation of being able to buy pounds back later at a lower price -- “shorting” -- is becoming less popular.

According to the Commodity Futures Trading Commission (CFTC), which measures changes in investor positioning, speculators had a net $3.2 billion (2.5 billion pounds) short position on the pound versus the dollar on Feb. 25. That is half the $6.5 billion hit in September 2018 and well below the $4.84 billion seen on Dec. 21, before the U.S. federal government shutdown.

CFTC offers the most reliable and frequent update of investor positions though its data measures only a tiny fraction of the market.

CFTC data was unavailable for some weeks due to the shutdown, and while figures are now trickling out, more up-to-date positioning indicators compiled by banks and funds show short positions are gradually being washed out.

BNP Paribas’s FX positioning tracker, for example, shows that on a scale of +50/-50, sterling ‘shorts’ were completely pared back in the week to March 4 for a score of plus 4, versus minus 5 the previous week. The score had ended 2018 at -30 and was -18 in the week to Jan. 21.

Separately, analysis by RBC Capital Markets of third-party flows data shows pound buying surged in two distinct rounds recently, especially against the euro, FX quantitative trader Robert Turner said.

“We’ve seen a huge amount of interest in buying sterling through our positioning monitor recently,” Turner said. “Most of the interest is in playing sterling strength versus the euro, rather than dollar.”

The first round was in the week of Jan. 21 and the second occurred on one day, Jan. 25, as markets ramped up expectations that a no-deal Brexit would be avoided. Purchases eased off after that but picked up again last week, he added.

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Investors had a small euro long position versus the pound in early 2019 of +11 percent, swinging to a record short of -100 percent on Feb. 27. The current score is -78 percent, RBC said.

RBC Positions and Flows - tmsnrt.rs/2ESpk6D

Similarly, Nomura’s positioning metrics indicate that net short sterling positions have declined to near their lowest levels this year, with a net short bet of less than $3 billion. At end-2018, net short positions amounted to $4.5 billion.

The sizeable drop in overall short pound positions gels with a reassessment of the chances of a no-deal Brexit -- major banks, including Deutsche and Goldman Sachs now assign just a 10-15 percent probability to that ‘worst-case’ outcome.

NOT CHEERFUL YET

Investors are far from cheerful on the pound’s prospects, however -- short positions at end-February, according to the CFTC, were well above a five-year average of $2.7 billion.

“There is a bit of optimism on the pound on hopes that a hard Brexit is avoided but the nature of any delay in the Article 50 process, or even an acceptance of May’s deal, introduces new possibilities and risks for investors to consider,” said UBS FX strategist Lefteris Farmakis.

Postponing the date of Britain’s planned departure or a tilt towards a softer Brexit than envisaged in May’s deal would open up the prospect of fresh negotiations between London and Brussels, dampening any knee-jerk rally.

Caution is also evident in options markets where investors have reduced their Brexit hedging or speculative bets, but not fully, according to traders.

Another index, compiled by currency fund Millennium Global Investments, shows pound positioning at -0.9 on a scale of -5/+5. It was -1.4 a week ago and around -1.7 a month earlier.

GBP positioning from Millenium - tmsnrt.rs/2EUXUNC

“Our positioning indicator shows positioning is still short as there is still a bit of uncertainty,” said Claire Dissaux, Millennium’s head of global economics and strategy.

“The Parliament has ruled out a no-deal Brexit but there is still the risk of domestic instability, as we have seen the parties split and an election still possible.”