Sterling zipped higher on Tuesday, reversing early losses after the speaker of the British parliament chose amendments to be voted on by lawmakers, including one that would effectively take a no-deal Brexit off the table.
The currency remains well off recent multi-month peaks however, and volatility in derivatives market was elevated, reflecting markets' nervousness about the likely outcome of the votes.
Parliament will debate and vote from 1900 GMT on Prime Minister Theresa May's response to the overwhelming rejection of her Brexit plan earlier this month.
But markets' main focus is on amendments proposed by lawmakers. The Speaker of the House of Commons, John Bercow, has chosen seven to be voted on.
In particular, markets are focusing on Amendment B, proposed by opposition Labour lawmaker Yvette Cooper, which seeks to shift control of Brexit from May's government to parliament. If successful, this could give lawmakers who want to block, delay or renegotiate Brexit a legal route to do so.
Amendment G by Dominic Grieve, a pro-EU Conservative, which would give lawmakers a chance to propose their own Brexit debates in parliament in February and March, will also be voted on. "I suppose given those amendents have been chosen markets may have discerned that a delay is a step closer," said Neil Mellor, FX strategist at BNY Mellon.
"The prominent amendments that have been chosen are too close to call (the outcome) but if the Cooper and Grieve amendments are carried, that is sterling positive." Cooper's amendment, which could delay Brexit, is considered likely to pass, especially after a source told Reuters the opposition Labour Party would back it.
Speaker Bercow's announcement sent sterling to a session high of $1.32 -having traded earlier in a $1.3160-$1.3170 range - up 0.2 percent on the day. But it remains well off 2-1/2 month highs of $1.3218.
It rallied against the euro too, rising 0.2 percent to a high of 86.560 pence but held well below Friday's 10-month highs around 86.18 pence.
Unicredit noted the pound had been this year's best-performing major currency so far, rising around 4 percent to the dollar and euro. On a trade-weighted basis, it is at a 2 1/2-month high.
"The risk that we get a disappointment in tonight's vote is clearly there," Unicredit FX strategist Kathrin Goretzki said, though she noted the vote would not significantly dent optimism that parliament had taken control of the Brexit process to avoid a no-deal scenario.
Another amendment selected for a vote, proposed by Conservative lawmaker Graham Brady, calls for the Irish backstop arrangement envisioned by May's Brexit divorce deal to be removed and replaced with "alternative arrangements".
May asked lawmakers to support Brady's amendment which, if passed, would show the EU that she can win parliamentary approval for the negotiated withdrawal deal if some changes are made to the Irish backstop plan.
Nervousness was reflected in a rise in implied sterling volatility on options markets, which has fallen steadily since the start of the year. Overnight implied volatility in particular raced to near 23 vol, the highest since Jan. 15, when lawmakers defeated May's Brexit deal.
One-month implied vol rose to its highest in a week and a half at 11.2 vol, a day after seeing the biggest one-day rise since November.
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