Pound volatility before EU summit shows Brexit woes escalating

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UK lawmakers are not the only ones bracing for a tough few months before Britain’s referendum on its European Union membership. A gauge of expected volatility for the pound near the highest since 2011 shows traders are expecting a rough ride too.

Sterling dropped to the weakest level in a year versus the 19-member euro last week amid concern British voters will opt to exit the world’s largest trading bloc. U.K. Prime Minister David Cameron is seeking to reach a deal with EU leaders at a meeting in Brussels starting Feb. 18 that may allow him to hold a vote as early as June. It extended its slide versus the dollar after Bank of England policy maker Ian McCafferty, who this month dropped his call for higher interest rates, said in an interview that an immediate increase is not necessary.

“Pound traders will likely play it cautious before the summit,” said Ipek Ozkardeskaya, a markets analyst at London Capital Group Ltd. “Brexit risks are two-sided. It is certainly not a comfortable setting for the bulls to lead the game. Yet not for the bears either.”

Six-month implied volatility for the pound versus the euro, a measure of anticipated price swings based on options, climbed to 11.84 percent on Feb. 11, the highest closing level since October 2011. It was at 11.58 percent as of 4:05 p.m. in London on Monday.

Sterling strengthened 0.6 percent to 77.16 pence per euro after dropping 0.9 percent last week. It depreciated to 78.98 on Feb. 11, the weakest since December 2014. The pound fell 0.4 percent to $1.4442.

Peer Performance

The U.K. currency has weakened against all but two of its 16 major counterparts over the past three months as Cameron stepped up negotiations with his European peers on a reform deal that he hopes will convince the British people to remain in the EU. Sterling dropped about 8 percent in December and January, its biggest two-month slide against the euro since 2008.

“The 18-19 February EU summit is widely perceived to be seen as the best opportunity to strike a deal,” Barclays Plc strategists including Singapore-based Angela Hsieh wrote in an e-mailed note. “We expect a correction lower in EURGBP should an agreement be reached at the meeting, although an impasse, to which we assign a non-negligible probability, would likely weigh on the pound.”

Investors are concerned that a vote to exit the euro region could damage U.K. growth, hampering the chances of the BOE lifting rates from a record low 0.5 percent. Forward contracts based on the sterling overnight index average, or Sonia, show traders aren’t fully pricing in a quarter-point increase to the BOE’s 0.5 percent bank rate until after April 2017.

U.K. government bonds were little changed, with 10-year gilt yield at 1.42 percent. The price of the 2 percent security due in September 2025 was 105.16 percent of face value.

“As long as the risk environment is negative, it is difficult for the U.K. to attract flows,” said David Kohl, Frankfurt-based head of foreign-exchange research at Julius Baer Group Ltd., which manages the equivalent of about $293 billion. “There is also this fantasy that the BOE will hike rates. The pound is among the least attractive currencies in G-10.”

(Bloomberg)

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