By Patrick Graham
LONDON (Reuters) - Running contrary to the norm on shock election announcements, the pound's steep gains on Tuesday point to hope among investors that the June poll may stabilise domestic UK politics as the country faces its biggest challenges in half a century.
Buffeted initially by speculation over the likely content of Theresa May's surprise statement, sterling bounced by a full cent after the prime minister called a vote for June 8, seeking to strengthen her parliamentary majority and bargaining position in talks on leaving the European Union.
London's main stock indices fell, but her decision encouraged major figures in the City, who have been worried so far by the government's strategy for the process and the fallout for the economy.
They hope it may give May more room to rein in her own Brexiteers to deliver a more orderly divorce from Europe while also allowing a reset of a weakened opposition Labour Party.
"The decision to call a snap election on June 8 is not without risk, but given a 20-point lead in the polls the Conservatives should be able to materially increase their working majority in parliament," said Mike Amey, head of sterling portfolio management at the bond fund PIMCO.
"That in turn would give the government more room for manoeuvre during the Brexit negotiations, and make the government less exposed to the more right wing factions within the party."
All this comes after a run of declines by the pound, which reduced one of the world's five big reserve currencies to levels not seen since a collapsed bid to join the euro in 1985.
Against the dollar, 2016 was the worst year for sterling since the 2008 financial crisis, and some strategists worried a flurry of negative headlines from the first blows in the Brexit talks over the next few months may weaken it further.
But one of the biggest bears, Deutsche Bank's George Saravelos, argued in a note after the announcement that it would be a game-changer for sterling, chiefly by giving May more room to negotiate and organise a slower, more orderly Brexit.
"It makes the deadline to deliver a `clean' Brexit without a lengthy transitional arrangement by 2019 far less pressing ... (and) second, it will dilute the influence of MPs pushing for hard Brexit," he said.
"We have been structurally bearish on sterling for the last two years but are now changing view. We are closing out all our bearish FX trades."
The story on stock markets since the vote for Brexit last June has been more complicated and, for the past nine months, is the flipside of sterling's fortunes.
London's main FTSE 100 index, made up chiefly of multinational companies whose international revenues get more valuable when sterling falls, has outpaced the rest of Europe's main markets since the vote last June. But it fell almost two percent as the pound gained on Tuesday.
Some argue the past gains for the FTSE, along with some of the major merger deals done since last year, also reflect the corporate world's confidence that sterling is unusually cheap - and will recover.
A better measure of stock market sentiment towards May's move may be the performance of domestically focussed firms in London's mid-cap index. They were down just 1 percent.
"If Theresa May’s Conservative Party can increase their majority in the snap general election called for 8 June, this should be bullish for UK equity markets and consumer confidence," said Henderson Global Investors' UK portfolio managers Neil Hermon and Indriatti van Hien in another note.
"The UK government would be in a stronger position to negotiate the terms of Brexit and May’s government would be given a definitive mandate for Brexit ... A positive move for UK stocks, particularly mid caps."
(Editing by Larry King)