By Richard Leong
NEW YORK (Reuters) - The euro and sterling rose on Tuesday following comments from a British official that signaled Britain and the European Union are close to clinching an agreement for the nation to leave the economic bloc as negotiators seek to avoid missing a deadline.
A stronger euro and sterling spurred profit-taking in the dollar, which reached a 16-month peak against a basket of currencies on Monday.
Uncertainty over the terms of Brexit has bogged down both currencies as a deal is required to keep business open between the EU and the world's fifth-biggest economy.
The euro's gain was limited by concerns about Italy's budget proposals and downbeat German investor sentiment data, traders said.
"News that the EU and U.K. nearly have a Brexit deal in place is injecting short-term flows into the common currency," said Viash Sreemuntoo, corporate trader at XE in Toronto.
Encouraging comments on Brexit negotiations lifted the pound to a 6-1/2 month peak versus the euro. Sterling reversed much of Monday's loss against the dollar.
"We are almost within touching distance now," British Cabinet Office Minister David Lidington, who is Prime Minister Theresa May's de facto deputy, told BBC radio.
At 10:49 a.m. (1549 GMT), the euro was up 0.52 percent at $1.12770. It had fallen to $1.1216, the lowest since June 2017.
The common currency was down 0.29 percent at 87.05 pence after touching 86.82 pence earlier Tuesday, which was the lowest since April 26.
Sterling was up 0.89 percent at $1.2964 following a nearly 1 percent drop on Monday.
An index that tracks the dollar versus the euro, sterling, yen and three other currencies (DXY) was 0.28 percent lower at 97.269, easing below a 16-month high of 97.693 reached on Monday.
In contrast to the latest news on Brexit, Italy's budget proposals remain a drag on the euro.
Tuesday is the deadline for Italy, the euro zone's third- biggest economy, to resubmit its budget plans to the EU after a showdown between Rome and Brussels over the government's 2019 spending plans.
The European Commission rejected Italy's draft fiscal plan last month and has threatened to impose penalties if it is not revised to conform with EU regulations - something Rome has indicated it is unwilling to do.
The International Monetary Fund on Tuesday warned the government's stimulus plan would leave Italy vulnerable.
The tension between Rome and Brussels has raised fears about Italy's membership in the euro zone.
"Italy is the big test case for the euro," said Joachim Fels, global economic advisor at PIMCO at the Reuters Global Investment Outlook Summit in New York. "That risk is not going away anytime soon."