LONDON (Reuters) - Sterling headed towards six-week highs against the dollar on Tuesday as investors continued to cut their short positions, even as Prime Minister Boris Johnson stuck to his pledge to take Britain out of the European Union by Oct. 31.
Analysts said investors were continuing to reverse their bets against the currency as they worried about being caught on the wrong side should the pound further extend a rally it started last week.
“This does come down to positioning,” said Jane Foley, an analyst at Rabobank. She said that if after the short positions were covered and there was no more good news on Brexit, sterling looked “vulnerable”.
A broader weaker dollar also helped the pound move higher on Tuesday.
Johnson is required by a law passed this month to ask the EU for a three-month delay to Brexit if a deal is not approved by Oct. 19, but British media reported that his team are looking at ways to circumvent it. Johnson said on Monday Brexit would happen on Oct. 31, with or without a deal.
Britain’s top court has started to hear the government’s argument that Johnson’s decision to suspend parliament until shortly before the Brexit date was not illegal as Scottish judges concluded last week.
His opponents say the suspension was aimed at impeding parliament from preventing a no-deal Brexit, an accusation Johnson denies.
“The decisive question for the pound exchange rates remains whether or not a no-deal Brexit at the end of October is de facto off the agenda,” Commerzbank analysts told clients, adding that the latest developments showed sterling’s recent rally was not justified.
The currency has firmed more than 3% in the past month, its gains accelerating after parliament passed the law ruling out no-deal Brexit. It jumped 1.3% last Friday, grasping at a headline — later denied — that Johnson’s Northern Ireland allies may soften their Brexit stance.
The pound was last up 0.4% at $1.2481 after losing ground on Monday.
Sterling on Monday touched a six-week high of $1.2515. The currency was buffeted by the volatile dollar, which rose late on Monday as oil prices eased and trade tensions with Japan appeared to cool.
Traders are now preparing for the U.S. Federal Reserve’s policy meeting this week.
Against the euro, sterling was flat at 88.56 pence having touched a three-month high on Monday.
With less than seven weeks until the Brexit deadline, Johnson is hoping a Brexit deal can be clinched at an EU summit on Oct. 17-18. He said a Brexit deal was emerging, but the EU said he had offered nothing to break the impasse.
Commerzbank noted that on options markets, insuring against a steep pound fall still carries a sizeable premium.
That shows “options traders do not exclude a major sterling bang”, they added.
Two-month implied sterling volatility, the contract encompassing the Brexit deadline and a possible general election, ticked up to a one-week high.
Graphic: GBP implied volatility, here
Two-month volatility was over 15 vols in early-September before tumbling last week to a 9.3 vols low. It stands now around 10.3 vols. Meanwhile, three-month volatility, with mid-December expiry, has risen one vol in the past week as investors try to price election risk.
Graphic: 3-month vol on the rise again, here
Also, reflecting Brexit jitters, Bank of America Merrill Lynch’s monthly fund manager survey showed investors increased their underweight on UK equities to 30% in September.
Additional reporting by Saikat Chatterjee,; Editing by Catherine Evans and Ed Osmond