May 31, 2017 / 8:52 AM / 2 months ago

UPDATE 2-Sterling bounces as new polls lean PM May's way

4 Min Read

* Two afternoon polls show double-digit lead for Conservatives

* Runs against earlier signs that majority shaky

* Risk reversals still point to more falls for pound

* Dollar slide helps recovery (New throughout after bounce on new polls)

By Patrick Graham and Ritvik Carvalho

LONDON, May 31 (Reuters) - Sterling recovered from its lowest level in more than a month on Wednesday after two surveys showed Prime Minister Theresa May's poll lead in double digits, countering signs she might be set to fall short of a majority in next week's election.

The pound sank as low as $1.2770 in early trade in London after a projection by polling firm YouGov pointed for the first time to a hung parliament that might instead see a left-leaning coalition take power.

But surveys released later in the day by research firms Kantar and Panelbase showed May's lead over the opposition Labour Party respectively at 10 and 15 points, giving the pound some respite

"It almost feels like we are just waiting for the actual results (of the election) now," said Lee Hardman, currency economist with MUFG in London. "We still think the Conservatives are going to win a larger majority."

A rollercoaster ride that also reflected sharp afternoon falls in the dollar's exchange rate against the euro, saw the pound up 0.3 percent and back above $1.29 by 1525 GMT.

It was 0.1 percent weaker on the day at 87.08 pence per euro.

That was still more than 1 percent down from 8-month highs hit last week on a view that that a landslide victory for the Conservatives would strengthen May's hand in Brexit negotiations and smooth Britain's eventual divorce from Europe.

The early falls propelled London's internationally-focussed FTSE blue chip index - which tends to rise as the pound falls - to a record high. It later retreated 0.1 percent as sterling recovered.

"We are expecting consolidation over the next week or so given the see-sawing in the polls," said Martin Arnold, currency strategist at ETF Securities.

Tory Certainty

Bookmakers still put the odds on a Conservative victory at more than 90 percent.

But the change in the polls is forcing investors to rethink some of the political logic behind the moves of the past month and also ask whether a victory for Jeremy Corbyn's Labour Party could even prove a positive for sterling.

Traditional financial market logic favours right-leaning parties who keep a tighter rein on public spending over those like Labour who tend to tax and spend more.

But the chances that a Corbyn-led coalition would seek a softer deal that kept Britain closer to Europe's single market - while also spending more to stimulate the economy in the near-term - makes the impact on the pound a difficult call.

"You could see a scenario like the U.S. election last year when the market tried to sell the dollar initially and then began to think about the actual policies and we instead saw a strong rally," said MUFG's Hardman.

"Were the government to lose its majority, it would give the other parties a greater influence. (That) could soften the Brexit outcome."

Option market bets on volatility - at rock bottom in recent weeks globally - have crept up slowly in the past week. Those for more weakness in the pound over the next month jumped to their highest since January after the YouGov publication.

The 1-month sterling-dollar risk reversal - a measure of the balance of bets for more weakness of the currency in the next month over those for more gains - was quoted as low as -1.388 .

"A market-friendly UK election outcome already appears priced and the risks are now skewed to a disappointment," Deutsche Bank analysts wrote in a note to clients on Tuesday.

"We like selling the pound both against the euro and the franc." (Editing by Jeremy Gaunt)

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