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LONDON (Reuters) - Sterling jumped as much as 1.6 percent against the dollar on Tuesday to hit its highest levels since mid-December, after British Prime Minister Theresa May surprised markets by calling for an early parliamentary election in June.
Standing outside her Downing Street office, May said she had decided "with reluctance" that an election was needed to secure political unity and stability as Britain negotiates its way out of the European Union.
Sterling jumped as high as $1.2772, its strongest since Dec. 14 and just shy of its highest in six months, as investors viewed the election as lessening political uncertainty and making it more likely that Britain could maintain some kind of preferential access to the single European market.
Deutsche Bank, one the world's biggest sterling bears, said May's election call was a "game-changer" for the currency, and that it would raise its forecasts for the pound in the coming days.
Analysts at the bank and elsewhere said May's move should result in a larger and more stable majority in parliament, thereby reducing the likelihood of the "hard Brexit" that markets fear.
"The election should hand Theresa May a much bigger mandate to stand up to the harder-line, anti-EU backbenchers who currently hold a disproportionate sway over her party's stance on Brexit," said Aberdeen Asset Management investment manager Luke Bartholemew.
"That would be welcomed by financial markets."
The pound also climbed over 1 percent to a four-month high of 83.79 pence per euro.
Its gains against the dollar put sterling on track for its biggest one-day rise since January, and prompted finance minister Philip Hammond to say in parliament in a rare comment on the currency that its rise showed markets were confident the Conservative government would win an increased majority.
"For the moment at least it is not being seen as particularly a negative," said Bank of New York Mellon's head of market strategy Simon Derrick.
"I guess people see that this may give Theresa May a better majority. It is a politically astute move and it should provide more stability going over the immediate aftermath of the exit from the EU."
Some were surprised by May's move - she has repeatedly said she does not want to be distracted by campaigning - but opinion polls give her a strong lead and the British economy has so far defied predictions of a slowdown in the aftermath of the Brexit vote.
Underlining divisions the vote is unlikely to mend, however, Nicola Sturgeon, first minister of the Scottish government, described the decision as a "huge political miscalculation" that could help her efforts to hold a new independence referendum.
The blue-chip FTSE 100 index - which tends to be inversely correlated with the pound because of its mainly foreign-earning constituents - closed the day down almost 2.5 percent, its biggest fall since the days after last June's EU referendum.
Reporting by Jemima Kelly; Additional reporting by Dhara Ranasinghe, Patrick Graham and Helen Reid; editing by John Stonestreet