By Tommy Wilkes and Saikat Chatterjee
LONDON (Reuters) – Sterling surged above $1.31 on Wednesday for the first time since early May, buoyed by growing expectations that Britain will avoid a hung parliament after next week’s election and also benefiting from a broader pullback in the U.S. dollar.
The currency had strengthened earlier in the day to seven-month highs as investors grew more confident the ruling Conservative Party would win an outright majority, removing some of the political uncertainty that has weighed on the currency.
Many appear to think a parliamentary majority under the right-leaning Conservatives would do more good for the pound than ongoing worries about a more decisive break from the European Union should Prime Minister Boris Johnson win the Dec. 12 election.
Polls have consistently given Johnson’s party a lead over the Labour Party. While Johnson has vowed to take Britain out of the EU on Jan. 31, Labour has said it will push for a second referendum on Brexit.
“The market continues to cut back on sterling short portfolios and hedges in expectation of certainty derived from single-party majority expectations,” said Neil Jones, head of FX hedge fund sales at Mizuho bank.
The pound strengthened almost 1% at one point to trade as high as $1.3110 <GBP=D3> though it slipped back to $1.3094.
Against the euro, the pound rallied 0.7% to 84.64 pence <EURGBP=D3>, another seven-month high.
Traders had reported some option structures above $1.30 fuelling demand for the pound. However, Refinitiv data shows around $1.5 billion in options clustered around $1.31, suggesting the currency could struggle to hold gains above that level.
The pound was little moved by the final IHS Markit/CIPS UK Services Purchasing Managers’ Index survey data, which confirmed that Britain’s services sector shrank in November.
Sterling has soared since October, gaining 6% since the prospect of a disorderly no-deal Brexit receded after the EU granted Britain a delay until Jan. 31. Investors have since latched on to the prospect of Britain avoiding a hung parliament.
Dollar weakness also triggered some technical demand, traders said. The greenback slipped 0.2% against a currency basket to plumb a new one-month low after data showed U.S. private employers added the fewest jobs in six months in November.
Graphic – GBP risk reversals: https://fingfx.thomsonreuters.com/gfx/mkt/12/9495/9407/GBP%20risk%20reversals.png
Five-year credit default swaps on British government debt are down around 5 basis points since the election was called in early November, as expectations grew that the Brexit impasse could be breached, according to IHS Markit.
Investors could grow more cautious as the vote approaches, with two-week implied volatility, a contract straddling the election, rising steadily to its highest since May <GBP2WO=>.
While sterling is at its highest against the dollar since May, the cost in the options market to insure against a setback is rising, too.
“FX traders will now ponder which way the risks are skewed as we run into election week with a feeling among some that the easy money has been made,” Adam Seagrave, head of global sales trading at Saxo Markets, said.
(Reporting by Tommy Wilkes; Editing by Louise Heavens and Giles Elgood)