UPDATE 3-Sterling soars to four-month high on hopes for Brexit delay

Sterling soared past $1.32 on Tuesday to its highest level since October following reports that British Prime Minister Theresa May will rule out a no-deal Brexit. May will propose to her cabinet of senior ministers on Tuesday that she formally rules out leaving the European Union without a deal, opening the door to a delay of weeks or months to the March 29 Brexit date, The Sun newspaper reported.

The planned offer, which raises hopes that Britain can avoid crashing out of the EU without a transition period in place to minimise economic disruption, comes after opposition leader Jeremy Corbyn said on Monday his Labour Party would back a second Brexit referendum. May is due to chair a cabinet meeting and then update parliament at around 1230 GMT. That all helped push the pound to its highest level against the euro since May 2017, up 0.9 percent to 85.88 pence . It rallied 1 percent versus the dollar to $1.3238.

"While a delay ... doesn't solve anything itself, markets are taking solace in the fact that such a move would delay a ‘cliff-edge’ no-deal scenario," said Michael Brown, an analyst at FX payment provider Caxton. With May struggling to get the changes she says she needs from the bloc to get her deal through a divided parliament, chances are rising that she will be forced to delay Brexit.

The immediate focus for traders is Wednesday, when parliament will vote on Brexit amendments and could seek to exert further control over the process. Labour Party lawmaker Yvette Cooper's amendment seeks to prevent a no-deal Brexit. It stands a good chance of being passed as three government ministers have added their support.

Some analysts say a short delay on Brexit negotiations is already priced in, however, and further gains for the pound will be difficult. "We've had a little tick up in the pound but the market has front-run these developments before, only to be disappointed," said Kallum Pickering, UK economist at Berenberg.

"There's a much more wait-and-see attitude." The optimism in the spot markets has yet to ripple over to the derivative markets, with one-month implied volatility gauges on the pound, a market indicator for future expected swings, edging lower but within striking distance of a six-week high.

One-week implied volatility remains elevated due to the uncertainty over the Brexit amendment votes on Wednesday. Risk reversals painted a slightly bullish picture with one-month gauges creeping higher in overnight trading.

A large buildup of options between $1.34 to $1.35 levels indicate that investors reckon the rally could go a bit higher but may not last beyond those levels. (Additional reporting by Sujata Rao and Richard Pace; Editing by Catherine Evans)