November 28, 2018 / 9:25 AM / 8 months ago

Sterling erases earlier gains after central bank Brexit warning

LONDON (Reuters) - Sterling gave up most of its earlier gains and traded broadly flat on the day after the Bank of England warned that Britain risks a bigger hit to its economy than the financial crisis if it leaves the European Union in a “disorderly” manner.

FILE PHOTO: Pound Sterling notes and change in a cash resgister in September 21, 2018. REUTERS/Phil Noble

The economy could contract by as much as 8 percent in a year and the pound could lose a quarter of its value, the Bank of England said.

The pound was trading broadly flat at $1.2744 per dollar after having hit a session high of $1.2806 earlier. Against the euro, the pound was broadly flat at 88.52 pence.

Barely four months before Britain is due to leave the EU, Prime Minister Theresa May is struggling to garner support from parliament for the agreement she sealed with EU leaders on Sunday.

The possibility of a no-deal Brexit sent the pound to a two-week low on Tuesday but the currency climbed as sentiment improved slightly after opposition Labour finance spokesman John McDonnell McDonnell was quoted by the Guardian newspaper as saying a second Brexit referendum “might be an option we seize upon”.

The comments raised hopes the Labour party could back putting Brexit to a second vote. McDonnell had been unenthusiastic about another referendum, although Labour has said it will act to prevent a “no-deal” Brexit.

“The market appears to be focusing on comments made by John McDonnell, suggesting a second referendum could be an option. That seems to have triggered some optimism and is helping the pound make some gains,” said Lee Hardman, a strategist at MUFG.

McDonnell told the BBC on Wednesday that another Brexit referendum is an option if a vote of no confidence fails to bring down the government or trigger a general election.

Stephanie Kelly, senior political economist at Aberdeen Standard Investments, said: “Eight months ago there was not enough momentum for a second referendum but a couple of things have changed and one of them is that the Labour party, albeit not explicitly, has a policy that it will pursue a second referendum in a world where it cannot get an election.”

    Traders were also digesting the government’s economic impact report released earlier in the day.

That forecasts that in a scenario resembling May’s plan, Britain’s economy would be 2.1 percent smaller in 15 years than it would be if the country remained in the EU. With no deal, it would be 7.7 percent smaller in 15 years.

Prospects of a negotiated exit from the European Union have restored some calm to the currency markets.

Overnight implied volatility on the currency, a gauge of expected swings, retreated from a post-Brexit referendum vote peak of 15.1 percent reached earlier this month.

Outright short positions on the pound have also nearly halved in recent weeks to a net short position of $3.4 billion, according to latest futures positioning data.

Still, currency analysts say that any significant recovery is unlikely ahead of next month’s parliament vote on May’s Brexit deal, which is shaping up as a key risk event.

“There’s an expectation that has been built up that because there is a second vote, the first vote won’t be used to vote the plan down,” said Jim Leaviss, head of retail fixed interest and manager of the M&G Global Macro Bond Fund.

“The danger is that everyone votes it down the first time around and it’s so far away from getting passed that, May has no option but to step down and call a general election effectively.”

Reporting by Dhara Ranasinghe and Sujata Rao; Editing by Robin Pomeroy

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