After the pound's worst week since Britain's 2009 recession, traders are betting there's more pain to come.
Sterling plunged 3.8 per cent versus the dollar this week after the referendum on Britain's European Union membership was set for June 23. The cost of six-month options suggests traders are the most bearish on the UK currency since 2010.
"It's difficult for the pound to make any headway at all - unbalanced growth, a trade and current-account deficit and the headwinds of Brexit," said Gavin Friend, a strategist at National Australia Bank, London. "We can easily see cable between $1.30 and $1.35 prior to June 23. You would be expecting sterling to come a bit lower on a trade-weighted basis as" markets continue to price out an interest-rate increase by the Bank of England.
The pound dropped between 2 per cent and almost 6 per cent against each of its Group-of-10 peers this week amid concern a vote to quit the EU would repel foreign investment needed to support the UK's current-account deficit. Economists surveyed by Bloomberg predicted that, if Britain voted to leave the world's largest single market, sterling would fall to lows against the dollar last seen in the 1980s.
The pound's 3.8 per cent drop in the week brought it to $1.3864 as of 5:15 pm Friday in London. It reached $1.3854, the lowest level since March 18, 2009. The UK currency weakened 1.9 per cent to 78.80 pence per euro since February 19.
While the referendum has accelerated the pound's declines, the currency had been falling versus the dollar since the middle of last year, leading into the Federal Reserve raising interest rates in December. Signs of a slowdown in global growth and low inflation have also undercut the pound, as they helped hold back the BOE from tightening monetary policy.
The central bank's governor, Mark Carney, warned his peers against getting enmeshed in a currency war by pushing interest rates too low, saying targeting weaker exchange rates only causes problems for the world economy. "Risk sentiment in financial markets has deteriorated sharply, stemming in large part from a renewed appreciation of weak medium-term global growth prospects accompanied by marked downside risks," Carney said in a speech in Shanghai as part of a two-day gathering of Group-of-20 finance ministers and central bankers.
For the pound, traders are bracing for more declines and greater price swings. Risk-reversals show the premium for options protecting against a decline in the UK currency in six months versus the dollar, compared with those insuring against an increase, reached as much as 3.8 per centage points, the most since 2010. The same measure for three month options, which cover part of the run-up to the referendum, reached 1.72 per centage points, the most since May.
Sterling "can travel a long way in a crisis," Bank of New York Mellon Corp strategist Simon Derrick said this week.
