LONDON (Reuters) – The pound fell to six-week lows versus the euro on Monday, also dropping against the dollar, as last-ditch trade talks between Britain and the European Union resumed in Brussels and investors re-evaluated the risk of a no-deal Brexit.
The sharp drop was a complete U-turn in market sentiment from Friday when sterling had risen above $1.35 for the first time this year.
The EU’s chief Brexit negotiator, Michel Barnier, is “rather downbeat” about the chance of a deal, a senior EU diplomat said on Monday.
“Markets are increasingly jittery to bad news having been willing to look through much of the negative headlines last week,” said John Goldie, FX dealer at Argentex.
At 1556 GMT, the pound was down 0.9% versus the dollar, at $1.3309, having fallen to the two-and-a-half-week low of $1.3225 earlier in the day.
Versus the euro, it was down around 1.1% at 91.205 pence – its weakest in more than six weeks.
Market participants were awaiting news about a phone call between Prime Minister Boris Johnson and European Commission President Ursula von der Leyen, which the European Commission said would be held at 1600 GMT.
Traders and analysts still believe that a Brexit deal is more likely than not, but options markets indicate that they expect further price swings as the Dec. 31 deadline approaches – when Britain leaves the EU customs union and single market.
Sterling implied volatility gauges with overnight and one-week maturities jumped to their highest since March, indicating that traders are bracing for future turbulence.
One-month risk reversals – a derivative used to hedge risk – also indicated the cost of protection against sterling falling is at its highest since 2016, excluding a peak in March this year.
In recent weeks, sterling traders had been more optimistic about the chance of a deal being struck. CFTC positioning data showed that, in the week to Dec. 2, speculators cut their net short position on the pound to its lowest in 5 weeks.
Concerns about Brexit pushed up the odds of the Bank of England cutting interest rates to negative territory in the coming months. Money markets are now pricing in as much as a 30% probability of a 10 bps rate cut by February 2021 compared to around 15% two weeks ago, according to Refinitiv data.
“Our view is if we were to have no deal it would more than likely bring the BOE back into play on the rate cut side,” said Tony Small, head of European rates strategy at Morgan Stanley.
“The market had moved far off any semblance of negative rate cuts and priced it out from the front end of the curve.”
The UK’s draft Internal Market Bill, which would undercut bits of the already agreed Brexit divorce settlement, is due back before parliament late on Monday.
