From 1988 to 1992 Peugeot produced another variant of the 205, the 205 Rallye, which was engineered and produced by Peugeot-Talbot sport. This edition of the 205 was positioned as a cost effective alternative to the 205 GTI, retaining its sporty character, but being less expensive to buy or maintain.
To achieve this, Peugeot used a derivative of the TU-series engine used in the post-1987 205s, which was designated TU24. The engine is essentially the same engine as was in the 1.1-litre 205 with the cylinders bored out to a total engine displacement of 1294 cc, a sports camshaft and twin Weber carburetors. While only a 1.3-litre engine, it still produced 103 PS (76 kW; 102 hp) at no less than 6800 rpm. The car got the 1.6 GTI front suspension with ventilated brake discs, and the 1.6 GTI rear axle with drum brakes.
The 205 Rallye was completely stripped of almost all soundproofing, electrical systems or other luxury items, bringing down the weight to no more than 794 kg (1,750 lb). Its minimalistic equipment, together with the high revs needed to unleash all of the engine's horsepower gives the 205 Rallye a very spartan character and makes it a difficult but rewarding car to drive hard, which is one of the reasons it is now very popular among 205 GTI enthusiasts.
Around 30,000 Rallyes were produced, and they were only sold in some countries on the European mainland (at least in France, Belgium, Spain and The Netherlands). This, together with the fact that a lot of these cars have been wrecked because it is a difficult (and for some drivers even dangerous) car to drive makes the 205 Rallye a very rare car nowadays. It is almost impossible to buy one in good shape anymore because Rallye owners now tend to hold on to their cars, knowing it will be a classic in the not-too-distant future.
The distinctive aesthetic features of the 205 Rallye include the squarer wheel arches (which are different from GTI arches), the steel body-coloured wheelrims and the rainbow-coloured Peugeot-Talbot sport decals on the front grille and the tailgate. They were only available in white and yellow. The Rallye was sold with a reduced-weight interior with the Peugeot-Talbot sport logo embroidered in the front chairs.
From 1990 to 1992 Peugeot also built a 1.9-litre version of the 205 Rallye. Only about 1000 of them were produced and they were only sold in Germany, because the 1.3 version did not meet German road regulations. The 1.9 Rallye is just a 105 bhp (78 kW) 1.9 GTI with the Rallye bodyshell and the new-style clear indicators and rear light units. Although they are even rarer than the 1.3 Rallye, they are less popular among Peugeot enthusiasts, because they lack the raw and spartan character of the 1.3 Rallye and are 150 kg (331 lb) heavier. Peugeot also released a Rallye version of the 205 in Great Britain, and used a TU3.2 engine. It had a 1.4-litre engine, which produced 75 bhp (56 kW; 76 PS) and achieved 107 mph (172 km/h) with a 0-60 mph of 11.7 seconds.
After the 205 Rallye, Peugeot again used the 'Rallye' designation for some of its 106 and 306 models.