November 28, 2016 / 4:20 PM / in a year

UPDATE 1-Italian referendum nerves push up euro implied volatility

(Adds trader and analyst comment, more details on price moves)

By Patrick Graham and Jemima Kelly

LONDON, Nov 28 (Reuters) - The cost of hedging against swings in the euro’s value over the coming week jumped by the most in months on Monday ahead of an Italian referendum that could prompt Prime Minister Matteo Renzi to resign.

Options market pricing showed a surge in the cost of hedging against volatility in the euro’s exchange rate to the safe-haven yen over the next seven days, for the first time covering the referendum on Sunday.

Implied volatility against the dollar also jumped but was still slightly less pronounced, pointing to doubts among speculative investors about whether the referendum would create clear and immediate threats to Italian debt markets and the euro project.

Italy, Austria and a host of other euro zone countries saw their cost of raising debt compared to benchmark borrower Germany increase on Monday ahead of the first of many political tests due in the coming months.

“There is plenty of risk priced in and people have been focused on it,” said the head of hedge fund currency sales with one large international bank in London.

“But if anything I would say there is more priced in to the 3-month, which takes in more of the Europe-wide political risks we have ahead. It does look to us like it will be a slow-burner (for the euro).”

One-week euro/yen implied volatility rose to as much as 14.375 percent, its highest in more than two months .

One-week euro/dollar implied volatility also jumped by the most in five months, hitting 12.480 percent, the highest since the night of Donald Trump’s victory in the U.S. elections earlier this month.

Three-month paper has been trading at or close to its highest levels since the Brexit referendum in June for the past 10 days and was also on the rise on Monday, even as spot rates for the euro strengthened.

“Since the U.S. presidential election, market attention has shifted to European political risks, prompting investor demand for euro vols,” said Credit Agricole strategist Stephanie Hau.

“In particular, the French presidential election next year has attracted the most interest.” The second round of the French presidential vote will be on May 7.

Renzi has promised to step down if he does not win the vote on constitutional reform, opening the way for renewed political instability in the eurozone’s third largest economy and prompting fears of bank runs and credit rating downgrades.

But the broader risks that poses - of a future government potentially taking Italy out of the euro, or taking policy moves that lead to markets forcing it towards a debt default - may take time to crystalise.

“There’s a broad consensus that ‘No’ wins this, and so exactly what?” said Kit Juckes, a strategist at another French bank, Societe Generale, in London.

“Markets are uncertain about what it means for the credit rating, does he resign, doesn’t he resign, does that cause an election or doesn’t it? Even if he does resign and it doesn’t cause an election, what does that mean in terms of the issues in the banking sector? That’s the thing - there’s much more uncertainty than something as simple as the Brexit referendum.” (Reporting by Jemima Kelly; Editing by Tom Heneghan)

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