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LONDON (Reuters) - Sterling looks set for a volatile run in to British elections next week but an argument can be made for markets reacting positively to a defeat for Prime Minister Theresa May's Conservatives, according to analysts from U.S. bank JP Morgan.
The Conservatives' lead has shrunk in some opinion polls to as low as 5 percentage points from close to 20 points a month ago, driving the pound lower in the past week.
That has seemed in line with traditional financial market logic, which has favoured right-leaning parties who keep a tighter rein on public spending over those like Britain's leftist Labour Party who want to tax and spend more.
But the U.S. bank - the world's second biggest trader of currencies, according to industry surveys - said the prospect of a softer Brexit from Europe under a Labour-led administration meant sterling might react positively to a defeat for May.
"A hung parliament would in more normal circumstances be viewed as quite negative for sterling," Paul Meggyesi said in a note distributed to media on Tuesday and sent to clients at the end of last week.
"But in the post-referendum world, all political developments need to be viewed through a Brexit prism and an argument can be made that a hung parliament which delivered or held out the prospect of a softer-Brexit coalition of the left-of-centre parties ... might actually be GBP positive."
Reporting by Patrick Graham, editing by Nigel Stephenson