November 1, 2018 / 7:40 AM / 10 months ago

Sterling has second biggest rise in 2018 on Brexit optimism, dollar woes

LONDON (Reuters) - Sterling rallied on Thursday on reports that London is close to sealing a financial services deal with Brussels, and as the Bank of England hinted that future interest rate rises would be slightly faster if Brexit goes smoothly.

FILE PHOTO: Wads of British Pound Sterling banknotes are stacked in piles at the Money Service Austria company's headquarters in Vienna, Austria, November 16, 2017. REUTERS/Leonhard Foeger

A British official said London was close to agreeing a deal giving UK-based financial services firms basic access to European Union markets. The British government and EU officials later played down the chance of an imminent deal.

The British currency also jumped more than half a percent against the euro as investors cheered raised expectations that UK financial institutions would not lose privileged access to the EU, a major concern for markets.

“This is a significant development for the pound as it alleviates some market concerns on how would London finance its big current account deficit,” said Ulrich Leuchtmann, a currency strategist at Commerzbank.

The financial services sector is a major contributor to Britain’s economy.

The BoE left interest rates on hold on Thursday but kept its options open, hinting at slightly faster future rate rises if Brexit goes smoothly. On the other hand it said all bets were off if next March brought a “disruptive” EU departure.

While markets don’t expect a BoE rate rise until well into the second half of 2019, the dollar’s deepening losses across the board propelled the British currency higher.

Sterling jumped to a day's high of $1.2954 and traded up 1.4 percent on the day GBP=D3 after the BoE's decision. It had been trading around $1.2915 before the central bank's announcement.

Thursday’s gains were the second biggest daily rise for the British currency this year and reflected a market that remained broadly short the pound.

Morgan Stanley strategists said currency market sentiment is extremely bearish on sterling, with the gap between implied and realised volatility higher than its long term averages.

Versus the euro the pound also rose nearly half a percent to 88.27 pence but was below the day’s high. EURGBP=D3

Sterling’s gains against the dollar left the pound on track for its biggest one-day rise since August, as hedge funds rushed to cover their short positions when sterling began to rise.

“Output gap closing and an economy running hot from late 2019 is generating further reductions in sterling hedges,” said Neil Jones, head of hedge fund sales at Mizuho Bank. “The BoE appears more hawkish than the market at a time when the Fed (Federal Reserve) and other central banks are gravitating in the same direction.”

Thursday’s gains follow a rise the previous day when Brexit minister Dominic Raab said he expected a deal on the terms of Britain’s departure from the bloc to be concluded with Brussels by Nov. 21. The government later said there was no set date for Brexit talks to finish.

“Ratification by the UK parliament (of any deal) could be problematic so (we) would be wary of predictions of lots more upside for sterling until that has been resolved,” said John Marley at FX risk management specialist, Smart Currency Business.

Reporting by Saikat Chatterjee and Tommy Wilkes; Editing by Hugh Lawson and David Stamp

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