Sterling consolidates after election surge

LONDON (Reuters) - Sterling hovered a cent below Tuesday’s six-and-a-half month highs against the dollar on Wednesday, the jury still out on whether it can make more progress on the back of optimism around the shock calling of a June 8 parliamentary election.

U.S. dollar and British pound notes are seen in this November 7, 2016 picture illustration. Picture taken November 7. REUTERS/Dado Ruvic/Illustration

Dealers said the pound’s almost 4-cent surge in the previous session, half of it in U.S. trading time after London dealers had gone home, had likely cleared out a large portion of the record bearish bets against the currency that have dominated trading since the Brexit referendum last June.

The prospect of a stronger majority and longer term for Prime Minister Theresa May, ahead of the opposition Labour Party by 20 clear points in opinion polls, has spurred hope of a slower, more orderly departure from the European Union after 2019.

But traders remain cautious on backing more gains into a weekend liable to be dominated by the first round of French elections. UK retail sales numbers on Friday could also provide more evidence of sinking consumer demand and economic growth into the election.

“It isn’t quite the one-way street that a lot of people have painted over the last 20 hours,” said Richard Benson, co-head of portfolio investment with currency fund Millennium Global in London.

“With a 20-point lead off the starting blocs, I would have thought the risk is more that it will narrow than grow. A positive surprise from the French election would also presumably see a squeeze higher in the euro after the weekend.”

After briefly gaining in early trade in London, sterling traded 0.2 percent weaker compared to the U.S. close at $1.2811. It was down 0.1 percent at 83.64 pence per euro.

While a larger Conservative majority would drive through the clean break with Europe that May has outlined and which has sent sterling lower since last June, it might also give her more room to make some of the big compromises needed to deliver a smooth exit.

French bank Societe Generale recommended selling options betting on falls and volatility in sterling, with a view to the pound strengthening above $1.30 in the near term.

“The worst may be behind us,” the bank’s analysts said.

Analysts from other major banks and investment houses for the moment seem to largely discount other potential post-election scenarios, like a surge for the pro-EU Liberal Democrats that could derail May’s plans.

“Could an ‘anti-Brexit’ political movement succeed? Not likely,” said Nomura strategist Jordan Rochester. “It would need the Lib Dems to have a 10 to 15 percent surge in the polling that we’ve only seen happen once (2010) in such a short amount of time.”

“Sterling is likely to continue to $1.30 before losing steam around $1.32 as the market proceeds to digest what a General election win for the Conservatives may bring.”

Two-month implied dollar-sterling volatility, covering the election, rose to its highest since March 23 but remained below 9 percent, far below peaks seen at other political and policy flashpoints over the past six months.

“We see this sudden announcement as just another symptom of the uncertainty in UK politics at the moment – and not a particular reason to buy or sell the currency,” HSBC analysts said in a note.

“A diminished opposition might allow the government a freer rein to push through its agenda. On the other hand, if a new intake of Conservative MPs were more centrist in their expectations of Brexit, then the voice of the ‘hard Brexit’ backbenchers would also be diminished.”

Reporting by Patrick Graham; Editing by Toby Chopra