The British pound strengthened against the dollar on Wednesday after investors reacted positively to reports suggesting the United States and Iran were moving closer to a deal aimed at ending the war.
Sterling rose 0.6% to $1.3621, trading near its highest level since February.
Against the euro, the pound remained largely unchanged, leaving the single currency at 86.35 pence.
The gains came after Axios reported that Washington and Tehran were nearing an agreement, easing some market concerns surrounding the ongoing conflict and its economic fallout.
UK elections add political uncertainty
In Britain, investors were also closely monitoring local elections scheduled for Thursday, with Prime Minister Keir Starmer and his Labour Party reportedly preparing for significant losses.
Repeated scandals and criticism over the government’s inability to improve living standards have fuelled speculation that Starmer could eventually be replaced.
The growing uncertainty has sparked concern among investors in the bond and currency markets.
Prediction market platform Polymarket showed nearly a 70% probability that Starmer could be out by December.
The figure has risen sharply from around 49% in early April.
A currency strategist at MUFG said investors could already be positioning for increased volatility following the local elections.
“More political instability could be on its way and investors could well be positioning for the potential for renewed political instability that could follow Thursday’s local elections,” the strategist said, as reported by Reuters.
Sterling still higher since Labour victory
Despite the current uncertainty, the pound has climbed nearly 7% since Labour secured victory in the 2024 general election.
During the same period, benchmark interest rates have fallen to 3.75% from 5.25%.
However, broader economic conditions remain difficult.
The British economy has shown little growth momentum, while inflation pressures have started to intensify again as energy prices surged following the US-Iran conflict.
Borrowing costs for mortgages and personal loans have also climbed to multi-year highs as gilt yields continued to rise.
Five-year gilt yields were trading around 4.53% on Wednesday.
That marked a sharp increase from 3.68% before the conflict began in late February.
Yields have also risen from 4.05%, the level recorded when Labour first came to power.
Business survey signals mounting price pressures
Fresh economic data also pointed to increasing cost burdens for UK businesses.
A monthly survey of business activity showed that British services firms experienced the strongest rise in price pressures in three-and-a-half years during April.
More than half of surveyed companies reported higher average costs.
The findings reinforced concerns that inflationary pressures could remain elevated, complicating the outlook for interest rates and the broader economy.
Options market remains relatively calm
Despite political uncertainty and rising economic pressures, currency options markets suggested investors were not yet preparing for extreme swings in sterling.
The cost of protection against large overnight moves in the pound declined alongside similar measures for other major currencies.
Overnight implied volatility for sterling, which measures the cost of hedging against sharp 24-hour currency moves, eased to around 6.83%.
That level remained near the middle of its recent trading range.
According to LSEG data, overnight implied volatility for euro/sterling also stayed relatively subdued at 2.71%.
A week earlier, the cost of hedging against potential election-driven currency swings stood around 6.27%, indicating that market participants were maintaining a relatively calm outlook ahead of Thursday’s vote.
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