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A historic pound rally was stopped in its tracks by doubts over whether a Brexit deal can win the approval of U.K. lawmakers.
The investor optimism that drove sterling up at the fastest pace since 1985 has mostly evaporated since U.K. Prime Minister Boris Johnson’s Northern Irish allies said they wouldn’t back an agreement reached with Brussels Thursday. With a critical Parliament vote on the deal due Saturday, options traders have become the most bearish on the currency over the next week since April, putting sterling’s 5% gains over the past week in doubt.
Investors are staying cautious as Johnson’s predecessor Theresa May saw her own Brexit deal rejected by Parliament three times, eventually toppling her leadership. Pulling it off would pave the way for an end to the political drama that has roiled U.K. markets for the past three years, while a rejection would open up the prospect of an imminent election or even a no-deal Brexit.
“You could see a 3% gain in sterling or a 3% loss depending how this vote goes,” said Marvin Barth, head of currency research at Barclays Plc, in an interview with Bloomberg Television. “We’re all just going to wait on the edge of our seats. If you haven’t put on a position yet it’s probably too late.”
U.K. markets have been in the grip of Brexit since 2016 with the pound being the main sentiment barometer -- it plunged to its weakest since 1985 in a flash crash in October that year. Sterling is still down 13% since the referendum, while the FTSE 100 share index has rallied 13% as a weak currency boosts British firms’ overseas earnings.
The pound edged up 0.2% at $1.2854 by 3:30 p.m. in London, after touching a five-month high near $1.30 earlier. U.K. government bonds reversed losses to send 10-year yields down two basis points to 0.70%, while the domestically-focused FTSE 250 stock index clung onto gains of 0.4%.
The EU’s chief Brexit negotiator Michel Barnier said he believes the deal can be ratified by the end of October, with European leaders looking at the details in a summit Thursday.Investors’ main focus will instead be on reaction from U.K. lawmakers ahead of the emergency U.K. parliamentary session slated for Saturday.
Pound-dollar risk reversals, a gauge of options market sentiment and positioning, stand at 104 basis points in favor of selling the pound over the next week, the most bearish sentiment for sterling in six months. That is also a turnaround from bets in favor of buying the pound on Wednesday.
Approval by Parliament is a major risk as Johnson does not have a majority and lawmakers remain divided on Brexit. Opposition parties including the Scottish Nationalists have already said they reject the deal, leaving the government reliant on votes from the DUP and rebels within their own Conservative Party and Labour.
The cost of hedging pound swings in the next week remains close to the highest since the 2016 referendum. Approval for the deal at the weekend sitting may lead to a pound rally to $1.40 but no further for Barclay’s Barth, while failure could mean a slide to $1.20 and below.
“Betting on further volatility still looks like a decent prospect, and better than taking a position in the spot price,” said Stephen Gallo, head of European currencies strategy at the Bank of Montreal.
--With assistance from Michael Hunter, Anooja Debnath, Liz Capo McCormick, Vassilis Karamanis, Hannah Benjamin, Alice Gledhill, Tasos Vossos and Jonathan Ferro.
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