Cost of hedging pound soars to near six-year highs on Brexit worries

LONDON (Reuters) - The cost of hedging against sharp swings in sterling surged to its highest in almost six years on Wednesday, three months before a June referendum on Britain’s European Union membership, and coinciding with narrowing bookmaker odds on a vote to leave.

An employee is seen walking over a mosaic of pound sterling symbols set in the floor of the front hall of the Bank of England in London, in this March 25, 2008 file photograph. REUTERS/Luke Macgregor/files

Sentiment towards the pound has soured this week after the resignation of a senior pro-“Brexit” minister and criticism of Chancellor George Osborne and his 2016/17 budget.

Sterling came under more selling pressure on Tuesday on a view that the deadly attacks in Brussels would boost the campaign to take Britain out of the EU.

Implied volatility on three-month sterling/dollar options, covering the period that includes the “Brexit” referendum on June 23, soared to 14.50, the highest level since mid-2010.

Three-month euro/sterling equivalents rose to 13.70, the highest since April 2009, according to Reuters data.

Options give holders the right to buy a currency at a pre-set exchange rate at a specific future date and are used either as protection against big swings in the rate or as a way to speculate on such moves taking place.

The three-month sterling/dollar risk reversals, a gauge of demand for options on a currency rising or falling, showed an increasing bias for sterling weakness against the dollar, trading at 4.5 vols - a measure of volatility - compared with 2.4 vols in favour of sterling weakness on Tuesday.

According to Reuters charts, these were levels last seen in the wake of the May 2010 general election, which resulted in a coalition government, and show a bigger skew in favour of sterling weakness than seen during the global financial crisis in 2008.

“Implied volatility on three-month options now captures the June 23 date. These are clean instruments to express concerns regarding the vote,” said Ned Rumpeltin, European head of currency strategy at TD Securities.

“Brexit is a very big deal for the UK economy and if Britain leaves the EU, it could lead to a significant devaluation of the pound.”

In the spot market, sterling fell below $1.42 to trade at $1.4160, down 0.3 percent on the day, as a new opinion poll showed that those wanting to leave the EU edging ahead in a tight race.

The ICM opinion poll of 2,000 people, carried out on March 18-20, showed support for the “in” campaign on 41 percent while that for the “out” camp stood at 43 percent.

Bookmakers’ odds on Britain choosing to leave the EU have tightened in the past few days, having started to narrow after the resignation of Work and Pensions Secretary Iain Duncan Smith on Friday which he said was over welfare cuts proposed in last week’s budget. The government said on Monday the planned cuts would not go ahead.

The resignation highlighted a deepening rift within the ruling Conservative Party.

“We see the pound staying under pressure ahead of the 23 June Brexit referendum,” Hans Redekar, head of currency strategy at Morgan Stanley said.

“The terrorist attack in Brussels and the Conservative Party looking more divided than in recent years do not bode well ahead of the vote.”

Reporting by Anirban Nag; Graphic by Nigel Stephenson; editing by Nigel Stephenson and David Stamp