By Marc Jones and Patrick Graham
LONDON (Reuters) - After months of Brexit uncertainty, the first faint outlines of a plan from Prime Minister Theresa May on Tuesday have given investors in Britain's pound something to work with at last - although substantial risks remain of the currency falling again.
May confirmed what most Westminster watchers had come to expect, that Britain will pull out of the European Union's single market when it exits the bloc and not look for a compromise deal to retain some of its benefits.
But, perhaps sensing that a Supreme Court decision would force her hand anyway, she said that parliament would get a vote on the Brexit deal and that firms would be given time to make the transition to the new arrangements.
Traders said the almost 3 percent rise in sterling <GBP=> against the dollar that followed - its biggest daily gain since at least 1998 - looked mainly like a squeeze on those who had already made money in six often chaotic months rather than conviction that its fall may be coming to an end.
Stefan Hofrichter, chief economist for giant German asset manager Allianz, said that in principle sterling at Tuesday's levels around $1.23 was significantly undervalued. But he remained reluctant to recommend buying it.
"It depends on the valuation measure but (it is) probably in the area of 20 percent (undervalued), which you could say is an argument to go long. But there are still a lot of uncertainties around it," he said.
"For the time being we still don't know exactly what Brexit means."
Prior to Tuesday's action, sterling had fallen 20 percent against the dollar and 14 percent against the euro <EURGBP=> since the Brexit vote last June.
That decline has come in often violent stages. It gained almost 6 percent against the dollar from late October to early December but then fell all the way back in an unbroken succession of weekly declines.
Investment bankers have grown more divided along the way. While many expect more weakness into the launch of Brexit talks in March, only 18 of the more than 50 economists and strategists polled by Reuters at the start of this month expected sterling to weaken to $1.18 or less within the next six months. [FXPOLLS]
The measures of positioning run by the U.S. Commodities and Futures Trading Commission as well as the currency world's big banking players all point to a large reduction in net bets against sterling from their peaks in mid- to late October. <1096742NNET>
That could be read as an indication of improving sentiment.
But it could also be seen as a sign that there is more space within the capital limits of big investors to bet heavily against the pound again.
"Despite the price move last week, clients have been slow to return to selling sterling," said Richard Cochinos, head of European G10 FX Strategy at Citi, the world's single biggest currency trader.
"Three out of Citi’s four client types were net GBP buyers last week, with leveraged GBP net selling so small it’s hardly worth mentioning. ... Ample room exists on the positioning & flow side to rebuild shorts."
As companies factor sterling's fall into their prices, inflation bounced back to 1.6 percent in December, and it is expected to accelerate in the months ahead.
Bank of England Governor Mark Carney hinted on Monday that there may be limits to how much price growth the bank can accept without responding with relatively tighter monetary policy, which would support the pound.
Finance minister Philip Hammond, speaking at the same time as May, warned that currency volatility may dampen investors appetite for funding Britain's large public debt.
"Clients are taking their time building positions, there is no firm conviction at the moment. In the short-term they are reassessing the drivers of the trends now," said Ned Rumpeltin, head of European FX strategy at TD Securities.
"A key level is $1.2430, also $1.2540-70. If cable trades above there, we are looking at a much more extended recovery."
(Editing by Hugh Lawson)