A More Volatile Environment for Pound Emerges on BOE Aftermath

(Bloomberg) --

Calm waters for the pound are now a distant summer memory as trading ranges widen and options suggest this higher volatility environment will persist.

Hedging costs for the U.K. currency have risen significantly since the Bank of England meeting last month, yet remain way off the extremes seen amid Brexit angst during the 2016-2019 period.

The pound fell by 2.5% since Sept. 23 after policy makers raised the prospect of raising interest rates as to contain a surge in inflation. Though it has since pared losses, downside risks remain, according to risk reversals, a barometer of market sentiment.

And while sterling may be looking for direction in the spot market, the same cannot be said for volatility. Cable’s term structure has not only shifted higher across tenors since the BOE meeting but is advancing further this week, which suggests further turbulence for the U.K. currency. 

What is striking is that the rally isn’t contained in short-term options trades. One-year implied volatility for the pound has risen on six of the past eight days and trades close to the 8% handle for the first time since April. The year-to-date average of the gauge stands around 40 basis points lower.

The relative premium on the one-year tenor, in other words the spread between implied and realized volatility, now trades above parity, which essentially means that options are overpriced. This has largely been the case since the Brexit referendum yet since May 2020 it has happened only on one occasion up until this week. 

• NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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