Sterling hovered around $1.36 on Wednesday and slipped to a one-week low against the euro as the US dollar came under pressure from news that Democrats were leading in a key election runoff that will determine control of the US Senate.
Market watchers believe a Democrat-controlled Senate would help economic growth globally and thus most riskier assets, but drag down bonds and the dollar as the US budget and trade deficits would be likely to grow.
The British pound rose as high as $1.3671 versus the dollar, close to a May 2018 high of $1.37 tested on Monday before easing back to around $1.36.
Against the euro, which traded at a new 2-1/2 year high versus the greenback, the pound slipped 0.4% at 90.6 pence.
While sterling rallied late last year in anticipation of a Brexit trade deal, analysts said it was the only G10 currency to have weakened against the dollar since the start of 2021, pressured by the expected damage to the economy from a new national lockdown announced this week.
“Lockdowns in England and Scotland… and anxiety over the UK’s trade in financial services with the EU are weighing on the pound,” Scotia Bank analysts said.
Financial services were not covered by the trade deal clinched between Britain and the EU late last month.
While predicting that the pound would regain the $1.37 mark amid a broad-based dollar decline, the Scotia Bank analysts added that it “looks likely to lag its key peers in the short run at least”.
One more factor is that money markets now expect the Bank of England to take benchmark interest rates into negative territory as early as May, compared with an August estimate just after the Brexit deal was struck.
And while bullish pound bets registered a fourth consecutive week of gains, according to weekly positioning data the size of the gains in the latest week is far smaller than in previous weeks.
Options markets imply a calmer sentiment towards the currency, with implied volatility continuing to decline — one-month volatility slipped to the lowest since last March and is down almost 3 percentage points since December 23, just before the deal was signed.
While the implied vol contract is well above that on the euro, yen and a G10 currency volatility index, the gap has narrowed sharply in the past two weeks.