August 9, 2018 / 9:40 AM / 2 months ago

Breakingviews - Sterling looks ripe for a short sharp bounce

LONDON (Reuters Breakingviews) - The worm sometimes turns. That could easily be the case for sterling, which has fallen to its lowest in nearly a year against the dollar and the euro. Its latest losses are largely due to growing concern that Britain might suffer a chaotic exit from the European Union. Even a glimmer of hope of a better outcome will spark a scramble to buy pounds.

UK pound coins plunge into water coloured with the European Union flag colours in this illustration picture, October 26, 2017. Picture taken October 26, 2017. REUTERS/Dado Ruvic - RC1FDF865E70

Sterling weakened as far as $1.2840 and to 0.9030 per euro on Thursday, both levels last seen nearly a year ago. The depth of gloom about how the currency will perform is even clearer in the derivatives market. Investors are willing to pay much bigger premiums for options that give them right to offload sterling rather than to buy it. Options which expire in one month show the preference to sell rather than purchase pounds for either euros or dollars has reached its most marked in just over a year. On a three-month horizon, this so-called skew is at its most pronounced since the last quarter of 2016 when it comes to sterling’s exchange rate against the euro.

This is not the only signal that market positioning is becoming unbalanced. The amount of net short bets reached its largest level since September 2017 in the week ended July 31, according to Commodity Futures Trading Commission data released on Aug. 3. As sterling has continued to fall, more such bets have probably been placed since then.

What makes these positions vulnerable is that they are based on little hard evidence that Britain is any closer to a hard Brexit than was the case a couple of weeks ago. One of the triggers for the pound’s fall was Britain’s trade minister, Liam Fox, on Aug. 4 putting the chances of such an outcome at 60-40. But this is as best a guesstimate and economists polled by Reuters are less pessimistic, assigning a median 25 percent chance of no agreement being reached.

Neither Fox nor economists know for sure and won’t for several months. That is plenty of time for policymakers, either in Britain or in continental Europe, to strike a more optimistic note and pierce, at least temporarily, the gloom that is surrounding sterling. That would give downbeat traders a shock.

Breakingviews

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