Pricing in no-deal Brexit, sterling tanks to 2 1/2-year low

The British pound has lost around 2.4 percent since Boris Johnson became prime minister.

    British pound sterling slumped to a 28-month low, dropping against the United States dollar and falling sharply against the euro [Chris J Ratcliffe/Getty Images]
    British pound sterling slumped to a 28-month low, dropping against the United States dollar and falling sharply against the euro [Chris J Ratcliffe/Getty Images]

    Sterling tumbled towards $1.21 and tanked to a two-and-a-half-year low against the yen on Tuesday, as growing concerns about the chances of a disorderly Brexit led investors to hedge or cut their exposure to British assets.

    The pound's fortunes are tied to the years-long process of negotiating Britain's exit from the European Union - and those fortunes have been increasingly suffering from signals of panic among investors that the United Kingdom is headed for a no-deal Brexit under new Prime Minister Boris Johnson.

    Financial markets had previously regarded that eventuality - which many economists believe would severely damage the British economy - as relatively unlikely.

    The British currency has shed around 2.4 percent of its value since Johnson took over last week, and is headed for its worst monthly performance since October 2016, just after the country voted to leave the EU. Sterling traded as high as $1.32 in May.

    "The tail risk of either a general election or no-deal Brexit were seen as a lower probability earlier but are increasingly getting priced in as a base-case scenario," said Supriya Menon, a strategist at Pictet Asset Management.

    There now seems to be less room for compromise between London and Brussels, she added.

    'Sterling to suffer'

    This week's selloff shows little sign of abating, with options markets implying more pain in store.

    A gauge of expected swings in the price of the pound before the October 31 Brexit deadline has jumped to the highest since before March 29, the original date for Britain to leave.

    Sterling selling has accelerated since Johnson - whose cabinet is packed with Brexit supporters - took over with the explicit agenda of taking Britain out of the EU by the end of October, whether transitional trading agreements are in place or not.

    GBPUSD 7/30/19

    Simon Derrick, chief currency strategist at BNY Mellon, said the no-deal Brexit shift had caught the market by surprise. "There's plenty of space for sterling to suffer because, when sterling moves, it tends to move very sharply," he said.

    The pound fell to a low of $1.21 in Asian trading and was down 0.4 percent on the day at around $1.217.

    Against the euro, the pound hit its lowest since September 2017, and by midday was trading around 91.6 pence, down 0.4 percent on the day.

    It lurched one percent lower against the Japanese yen to the lowest level since November 2016, falling past 132.28 yen, to which it plunged during a "flash crash" episode in January.

    Adding to concerns is the possibility of a snap election, which could well see Johnson strengthen his position. Weekend opinion polls showed his Conservative Party with a significant lead over opposition Labour.

    The current Parliament of the United Kingdom is resolutely opposed to a no-deal Brexit. But an election that provides Johnson with a big majority could allow him to overcome that obstacle.

    "Sterling isn't cheap enough to buy until EUR/GBP is the other side of 0.95, and there isn't the faintest glimmer of positive news on the horizon," said Kit Juckes, a currency strategist at Societe Generale who described the pound as "parachute-less".

    Options markets suggest investors expect heightened sterling volatility in late September and early October, when the UK and EU parliaments return from summer recess. By then, a clearer picture should emerge of where Brexit negotiations are headed.

    Odds of a no-deal Brexit have narrowed since Johnson came to power, although bookmakers generally see a no-deal Brexit in 2019 as less likely than Britain leaving with an agreement in place - or the departure date being postponed once again.

    SOURCE: Reuters news agency