LONDON (Reuters) - Sterling surged above $1.31 and hit its highest level in about 2-1/2 years against the euro on Wednesday, lifted by growing expectations that Britain will avoid a hung parliament after next week’s election and a broader pullback in the U.S. dollar.
Forecasts that the ruling Conservatives will win an outright majority, removing some of the political uncertainty that has weighed on the currency, has encouraged investors to move back into the pound - pushing it past key technical barriers.
“In terms of cable (sterling/dollar) and euro/sterling, we’ve been trading at $1.30 and 85 pence respectively in the last few weeks and not managed to break through until today,” said Kenneth Broux, a currency strategist at Societe Generale.
“Technically these are important levels. I think some investors may be saying to themselves, well you know what, the polls haven’t changed much so let’s put a bit more money on the table, add to long sterling positions.”
The pound strengthened almost 1% at one point to trade as high as $1.3120 GBP=D3. It had slipped back a touch to $1.3104 in late trade, still poised for its biggest one-day jump since mid-October.
Sterling also shot higher against the euro. It rallied almost 0.9% to 84.54 pence EURGBP=D3, its highest level since May 2017.
Polls have consistently given Prime Minister Boris Johnson’s party a lead over the opposition Labour Party. While Johnson has vowed to take Britain out of the European Union (EU) on Jan. 31, Labour has said it will push for a second Brexit referendum.
“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.
Traders had reported some option structures above $1.30 fuelling demand for the pound.
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 7% 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.
Five-year credit default swaps on British government debt are down around 5 basis points since the election was called in early November, according to IHS Markit.
The British currency also benefited on Wednesday from a weak dollar, which took a hit from disappointing economic news.
Data showed U.S. private employers added the fewest jobs in the six months in November, while services sector activity slowed more than expected last month.
Graphic - GBP risk reversals: here
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,” said Adam Seagrave, head of global sales trading at Saxo Markets.
Reporting by Tommy Wilkes and Dhara Ranasinghe; Additional reporting by Saikat Chatterjee; Editing by Giles Elgood and Andrew Cawthorne