Sterling falls as probability of hung parliament grows

The pound was sluggish on Monday as polls showed that the Conservative Party was leading albeit with a smaller advantage, increasing the probability that the Dec. 12 UK election will end in a hung parliament.

British Prime Minister Boris Johnson's Conservative Party has held its 7-point lead over the opposition Labour Party, according to an opinion poll by ICM for Reuters, the first to be conducted entirely after Friday's attack near London Bridge.

Earlier in the day, however, the Conservative (Tory) Party's lead over Labour had narrowed to 9 percentage points in the past week, a Survation poll for ITV's Good Morning Britain said on Monday.

"For me that's probably taken some shine off sterling," said Neil Jones, head of European hedge fund sales at Mizuho.

Sterling was last down 0.1% at $1.2935. It was flat against the euro at 85.54 pence. The pound has recovered slightly since last week from around $1.28 and 85 pence per euro.

Option prices showed that investors have been preparing for unexpected moves in the British currency during the election. Implied volatility gauges have risen to 13.7 vol, the highest in six weeks. Volatility across other major currency pairs was near record lows.

Speculators still held net short positions on the pound in the week to Nov. 19 of $2.58 billion, latest CFTC data showed, though volumes were relatively low for this year.

A Conservative majority in parliament would make it easier for Johnson to pass the Brexit deal agreed with the European Union in October, restoring some certainty to the UK's exit from the EU, analysts say. This conviction has pushed the pound higher in the past two weeks as polls pointed to a higher probability of a Tory majority.

"There are increasing parallels with the way polls played out in 2017 with what we're seeing now, so that could cap the upside for sterling," said Jeremy Stretch, currency analyst at CIBC.

Three and a half years after Britain voted to leave the EU, markets still don't know whether the third Brexit deadline will be met on Jan. 31 or whether Britain will be able to negotiate a favourable trade deal if it happens.

The long stretch of uncertainty has hurt the British economy, prompting the Confederation of British Industry and a manufacturing trade body, Make UK, to downgrade their growth forecasts for next year.

Official figures have shown that Britain's economy is growing at the weakest annual pace since 2010, and industry leaders see little or no improvement in 2020, even if Johnson wins re-election and secures an agreement by the Jan. 31 deadline.

Still, the final British manufacturing purchasing managers' index was revised to 48.9 for November, up from 48.3 in October, where it was expected to stay, without much effect on the pound.