Sterling is having a relatively stellar Friday after surging overnight to above $1.35 as investors rushed to unwind bets on a weaker pound after a resounding election victory by Prime Minister Boris Johnson’s Conservative Party.
Johnson’s win will allow him to end three years of political paralysis and take the United Kingdom out of the European Union in an orderly manner in a matter of weeks.
The pound was last trading up 1.6 percent at $1.3393, giving up some of the gains it made overnight when it rocketed to a 19-month high of $1.3516.
The pound had jumped more than 2.5 percent – its biggest one-day gain in nearly three years – after exit polls suggested a Conservative landslide was in the offing.
This was a remarkable jump for a currency that has become extremely volatile since Britain voted to leave the EU in a 2016 referendum.
Vasileios Gkionakis, global head of FX strategy at Lombard Odier, said he had now sold sterling after increasing his holding in the currency when it was languishing at $1.26.
“We just took profit here,” he said. “From a risk-reward perspective it makes sense to take profit.”
But Gkionakis believes sterling could rise to $1.40 as there was a chance Johnson could now seek to extend the post-Brexit transition period beyond December 2020 to complete negotiations on a future trade deal with the EU. During the election campaign, the prime minister had pledged not to do this.
Moreover, with a strong majority in parliament, “Johnson will not rely on Eurosceptics to hold him hostage,” Gkionakis said.
Analysts from HSBC expect sterling to rise to $1.45 and to 76 pence against the euro by the end of next year, now that the “politically driven undervaluation” has been removed. It had previously forecast targets of $1.37 and 80 pence.
HSBC said that sterling will again be driven by economic data after years of being politically driven.
In the options market, the premium for pound puts over calls – the right to sell pounds versus the right to buy them – during the next week shrank to its lowest since mid-November, a day after it reached its highest since September 2016.
That means fewer investors expect the pound to lose value over the coming week.
On top of that, the three-month sterling implied volatility gauges, which include the January 31 Brexit deadline, have fallen to a five-month high, suggesting traders have removed protection against unexpected moves in sterling.
Expectations of aggressive rate cuts by the Bank of England are also scaling back as investors bet that fading political uncertainty will prompt policymakers to take a more optimistic view of the economy.
“The potential for a smooth Brexit removes some of the downside risk for the UK economy, and this should be positive for both business and consumer confidence,” said Guy Foster, head of research at wealth manager Brewin Dolphin.
Along with the pound, the mid-cap stocks index FTSE 250, which is home to many companies with high UK revenues, surged about 5 percent to record highs.