FX Focus: Pound recovers as May backtracks on 'dementia tax'

The pound endured a very volatile session, after the Conservative Party's proposal for controversial social care reforms left voters unimpressed.

The response the so-called "dementia tax" saw Labour slash the Tories' lead into single figure for the first time, prompting markets to fear next month's election might not be the landslide Theresa May triumph most expected until last week.

Sterling, which hit a seven-month high against the dollar on Friday (19 May), was not exempt by the fallout and shed half a cent, falling to $1.2970 in early trading. The pound, then climbed back above $1.30, after the Prime Minister backtracked on her manifesto, admitting her government would introduce a cap on the amount amount that people would have to spend when paying their care costs.

However, sterling remained 0.22% and 0.54% lower against the dollar and the euro respectively, trading at $1.3007 and €1.1569.

"While a nine-point lead could still give May a comfortable victory on 8 June, the fact her lead has been slashed in half in just a few days may reinforce to financial markets that her victory is not a certainty," said Kathleen Brooks, research director at City Index.

"With three weeks to go before the election, another bad PR week for PM May and her team and the Tories' lead over Labour could fall further into the low single figures, which could encourage sterling selling ahead of this crucial vote."

Neil Wilson, senior market analyst at EXT Capital, added: "Polls still point to a Conservative majority but a repeat of David Cameron's 2015 win is not enough. If May fails to get the thumping majority she hopes for, her position could look less secure than before she called the snap election. Calling an election is a gamble even if the odds remain stacked in her favour.

"May has made this campaign particularly personal and a failure to secure a large swathe of new Tory MPs would be seen a failure of hers."

Euro surges as Merkel blames ECB

Elsewhere, the euro hit a six-month high, after German Chancellor Angela Merkel said the common currency was too weak and blamed the European Central Bank for the record German trade surplus.

The comments, made in front of a group of school children in Berlin, sent the euro to $1.1248, its highest level against the dollar since November last year. The latter remained under pressure, failing to register any meaningful gains against the Canadian dollar and the yen and falling 0.27% and 0.22% against the Swiss franc and the Australian dollar respectively.

"The green back has lost its mojo and with markets still putting significant odds in favour that the Federal Reserve would increase the interest rate in June, we are just not seeing the kind of the same rally which we have in the equity market," said Naeem Aslam, chief market analyst at Think Markets UK.

"Investors will be looking at the latest Fed minutes due on Wednesday. Their interest will be to find any sort of indication in to the policy makers thought process in relation to what they are planning in reducing the size of the balance sheet."