UPDATE 1-Sterling gains after EU source welcomes new UK Brexit proposals

Sterling gained on Thursday after a European Union source said new British proposals for avoiding extensive border checks in Ireland after Brexit were "a step in the right direction" and "make finding a compromise possible".

Britain is trying to overcome one of the thorniest issues in the Brexit negotiations: a "backstop" deal to protect an open border between Northern Ireland, part of the United Kingdom, and EU member Ireland, should the UK leave the EU without an overall exit agreement.

An EU source close to the negotiations told Reuters that Britain's new proposals were positive. That followed other signs this week that London is making progress towards a Brexit agreement before the UK quits the EU in March.

The Financial Times reported that Ireland backed one of UK Prime Minister Theresa May's proposals - for the whole of the UK to operate within a customs union with the EU - if no other solution to the Irish border issue was found.

MUFG analysts said that rather than weaken as feared during this week's conference of May's ruling Conservative Party, sterling had been given a boost by the Irish reports.

"The EU would have to provide some encouragement as well that it is warming to the idea for the pound to stage a rally in the coming weeks," they said.

May's conference speech on Wednesday lacked anything new to shift market sentiment and the pound was little changed.

After falling as low as $1.2922 overnight - its weakest since Sept. 10 - sterling rallied to as high as $1.2993, up 0.4 per cent on the day, with most of the gains following a Reuters report on the possible Irish border solution.

Britain's currency also gained versus the euro and was up 0.3 per cent at 88.54 pence.

In her speech, May appealed to her party to unite behind her plan to leave the EU, warning critics their disputes could put Brexit in jeopardy.

May's officials plan to rush her Brexit deal through Parliament to stave off a rebellion from her own party, Bloomberg reported on Thursday.

"Somehow, everything seems to be rather deadlocked at the moment, and as a result, the downside risks for sterling remain in place," Commerzbank analysts said in a note to clients.

The pound is likely to be stronger by the time Britain leaves the EU, according to currency strategists polled by Reuters, but in a year it still won't have recouped its losses since the 2016 Brexit vote. 

(With inputs from agencies.)