At the Bank of England’s first meeting of the year, Governor Mark Carney tapped into the Brexit conundrum facing pound traders the currency’s next move is likely to be a big one.
Sterling has pulled back this month to hover below $1.30 after rallying in January as no solution is yet in sight to avoid Britain crashing out of the European Union in less than 48 days. A resolution could move the currency as much as 20 percent in either direction, with traders unwilling to put money on the line when the chances of no deal are roughly as likely as a deal, according to Commerzbank AG.
The economic “fog of Brexit”, as cited by Carney last week, may be reflected in manufacturing and gross domestic product data this Monday. Investors will then focus on the political debate, with the government due to present a Brexit motion to Parliament Thursday even though Prime Minister Theresa May hasn’t won concessions from Brussels so far to persuade lawmakers to back her deal.
Sterling is “probably the worst currency to trade at the moment,” said foreign-exchange strategist at Commerzbank. “The probabilities of a no-deal Brexit and a deal are very close to each other, so we will definitely get a large move once there is a decision for either one.”
The pound has oscillated around $1.30 for much of the past six months. Investors are buying low-delta options that would pay out with a move to $1.25 or $1.35, with puts favored, according to traders. Two-month risk reversals, covering the March 29 Brexit deadline, are at the most bearish level for sterling since November.
The BOE downgraded its growth forecasts last week and money markets are not pricing an interest-rate hike this year. Data next week is expected to show price pressures softened further in January.
The probability of a no-deal Brexit has increased, Carney warned Thursday, adding that a big bout of financial volatility may be around the corner.
“It would be remarkable if the current levels of sterling and U.K. asset prices was consistent with the outcome that finally emerges,” Carney said. “We do not know what form of arrangement could be struck.”
With both May and EU negotiators agreeing to keep talking, Credit Agricole SA is upbeat on the eventual outcome. It recommends a six-month call spread, targeting a move toward $1.37 a near 6 percent appreciation from current levels.
“Clients still seem willing to participate in the game of chicken that the U.K. and the EU politicians have been playing,” said Valentin Marinov, head of group-of-10 currency research at the bank. “It seems that investors are still far from panicking.”