LONDON: Sterling fell nearly half a percent with the outlook turning bleak as traders increased their bets on a no-deal Brexit before the result of the Conservative party’s leadership election.
The pound’s weakness was in sharp contrast to the general calm in the developed market currency space and signalled growing unease among investors over the likelihood of Eurosceptic former foreign minister Boris Johnson becoming the next prime minister.
“The market will look to price in the chance of a no-deal Brexit at 50/50,” said Neil Jones, head of European hedge-fund sales at Mizuho. Morgan Stanley said it now saw a 30% chance of Britain leaving the EU without a deal compared to 25% earlier.
The last votes to choose a new Conservative party leader were expected to be handed in late yesterday, followed by an announcement today. Party activists choose the leader, expected to replace Theresa May as prime minister.
The pound was last down 0.3% at US$1.2467, not far from the 27-month low reached last week, having declined 1.8% against the dollar so far this month. Against the euro, it also fell to 89.98 pence.
Currency and bond markets have been rattled by fears that a British government under Johnson would increase the risk of a no-deal Brexit, as he repeatedly said that Britain must leave the European Union by Oct 31 with or without a deal.
Market participants have been buying more options to protect against losses in sterling since early May and have consolidated their positions in the past few days, according to three-month sterling risk-reversals, which measure demand for buy and sell options on the British currency.
Three-month implied volatility in the pound has risen since the beginning of the month and has hit its highest level since early April, signalling traders are bracing for a rocky ride for the pound in the currency markets.
Still, levels are well below the highs achieved before Britain’s initial March 29 deadline to leave the EU, which was extended after May failed to pass a withdrawal deal in parliament.
Hedge funds have also increased their short positions on the pound to US$5.94bil via currency futures in the week to July 16, a 10-month high, based on data provided by the Commodity Futures Trading Commission.
“Sterling shorts have grown further and are moving in line with both euro/pound and pound/US dollar,” said Kit Juckes, macro strategist at Societe Generale. — Reuters