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Pound pulls back from rally as Brexit negotiations hit hurdle

Traders are snapping up options that insure against big moves in unit, as sterling faces two sharply different paths

London

THE pound pulled back from a rally as the chances of an imminent Brexit deal faded on objections from a Northern Irish party.

Sterling has surged the most since 2008 in the past four days as traders gained confidence in a potential end to the Brexit saga.

Negotiators had showed optimism of a breakthrough on Tuesday and the talks were to resume in Brussels on Wednesday, having made progress late into the night, officials said.

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Yet the United Kingdom government is pessimistic after opposition to the plans from the Democratic Unionist Party (DUP), an official said.

Traders are snapping up options that insure against big moves in the currency, as the pound faces two sharply different paths. A deal and parliamentary approval would see the rally extended to US$1.40, but failure could send the UK towards an economically disruptive no-deal outcome and a sterling plunge to US$1.11, according to strategists in a Bloomberg survey.

The currency market hasn't been this jumpy over Brexit since the aftermath of the referendum that set the process off in 2016.

The past few days have been tumultuous for UK markets, with conflicting Brexit headlines forcing traders to reposition for a swift and brutal move once there is clarity on how Britain will exit the bloc.

According to European Union (EU) officials, Britain has made several big concessions in recent days to secure a deal, including accepting there will be customs checks between Northern Ireland and the rest of the UK - something opposed by the DUP, an ally of the ruling Conservative Party.

Any deal could be signed off by European leaders at a summit starting on Thursday, yet would still have to get through Parliament.

"Current enthusiasm for a deal is being tempered by the reduced chances of the deal passing though the UK Parliament even if the UK and EU agree," said Neil Jones, head of currency sales for financial institutions at Mizuho Bank Ltd. "The pound will probably return to the downside until the market expects a deal to succeed in Parliament."

The pound dropped 0.6 per cent to US$1.2707 by 9:00am in London, having touched an almost five-month high of US$1.28 Tuesday. Against the euro, it weakened 0.7 per cent to 86.85 pence. UK government bonds opened stronger, with 10-year yields down three basis points to 0.67 per cent, while the UK's domestic-focused FTSE 250 stock index fell 0.9 per cent.

Option traders are pricing high levels of volatility over the coming week on the potential for a further rally if a deal can be signed off by the region's leaders - or a slump if the talks break down. One-week implied volatility in the pound-dollar pair surged to 20.07 per cent, the highest since July 7, 2016.

Any deal or need for more time is likely to be debated by an emergency session of the UK Parliament on Saturday. Morgan Stanley sees a 65 per cent chance of a Brexit deal, up from 55 per cent last week, yet expects Parliament to reject it, which it sees leading to a further extension and elections to decide the way forward on Brexit. BLOOMBERG