Pound Drops After Brexit Saga Brings BOE Rate-Cut Bets Forward
Pound Drops After Brexit Saga Brings BOE Rate-Cut Bets Forward
(Bloomberg) -- British Prime Minister Boris Johnson’s hard-line negotiating tactics with the European Union are once again unsettling U.K. markets.
The pound slumped for a fifth day, the longest losing streak since May, with bearish bets on the currency jumping by the most on a net basis since March. Money market traders are stepping up bets on negative interest rates, dragging the yield on two-year bonds to a record low, and the FTSE 100 Index dropped as much as 1.2%.
Johnson has threatened to walk away from Brexit talks without a new trade deal, despite warnings that a hard split would cripple economic growth. Investors were also spooked by comments from the Bank of England’s chief economist in support of ending the wage-support programs, and reports that the head of the government’s legal department had quit.
“The tense start to the next round of Brexit negotiations has provided the main catalyst,” said Ned Rumpeltin, European head of foreign-exchange strategy at Toronto-Dominion Bank. “There remain underlying concerns about the strength and sustainability of the U.K.’s recovery.”
Brexit had been a key driver for the pound ever since the 2016 referendum, but it was relegated this year after Covid-19 took its place. Year-end trade risks were never a secret yet are now facing full scrutiny from investors. In such an outcome, both sides would face costly quotas and tariffs on goods trade, and enormous levels of disruption at the border.
“There has been a certain level of fatigue in the pricing of Brexit risk,” said Simon Harvey, a currency market analyst at Monex Europe Ltd. “Markets assumed that the economic damage of a no-deal exit during such a vulnerable time for the U.K. economy would mean that policy makers would try to find consensus for a deal.”
Economists from Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley all still anticipate a deal on commerce will be in place in time for the end of December. Yet Tuesday’s moves suggest broader doubt is creeping in.
Currency option prices signal traders are concerned about the pound over year-end when the Brexit transition period will expire.
Sterling could weaken by about 2% in the coming weeks toward 0.92 per euro if markets increasingly price in a failure of trade talks, according to Rabobank’s head of foreign exchange strategy Jane Foley.
“The risk of a no-deal Brexit is very real,” said Jordan Rochester, a currency strategist at Nomura International Plc. “We would ascribe a 40% probability of this being the end outcome, but that could rise to no better than 50/50.”
And money markets are betting the central bank will cut rates by 12 basis points in May, which would push them into negative territory. As recently as Monday, traders were factoring in rates remaining above zero until September 2021.
Given that heightened tension is driving investors to seek the safety of government debt, Britain’s first syndicated bond offering since June attracted bids in excess of 76 billion pounds ($99 billion).
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