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Pound-US dollar parity is an idea that's starting to take hold
SUDDENLY, the idea of pound parity seems less far-fetched as the risk grows that Britain may split away from the European Union without a deal.
Rupert Harrison, a fund manager at BlackRock Inc, is short the pound and sees the risk of it falling to trade level with the US dollar on a no-deal Brexit. The view echoes Morgan Stanley's recent forecast that the currency can plunge towards US$1 on such an outcome.
That isn't the majority view yet - a Bloomberg survey this month estimated that the pound will slide to US$1.10 should the UK exit the bloc without an agreement.
New Prime Minister Boris Johnson has repeatedly said that Britain will leave the EU on the Oct 31 deadline with or without an agreement, fuelling concern that the nation is headed for a disorderly departure and fanning pessimism towards the pound. Sterling has fallen more than 7 per cent in the past three months, the worst performance among major developed market currencies.
"The pound is at a much lower level now but I still think a no-deal exit would lead to significant volatility and we could be testing parity on a really bad outcome," said Mr Harrison, who manages more than US$10 billion in assets at BlackRock. "We will see this game of chicken continue through August and that's likely negative for sterling," he said about the deadlocked Brexit talks.
The pound fell 0.8 per cent to US$1.2033 on Friday, its weakest closing level since the 1980s, after a report on the second quarter showed the UK economy shrank for the first time in six years. The data mean that it is likely that the Bank of England will cut interest rates, according to Mizuho.
The BOE said in November that the currency could fall even below US$1 in an analysis on possible worst-case Brexit scenarios. Options-based calculations showed around a 6.4 per cent chance of pound-US dollar parity in the next one year, markedly higher than 0.2 per cent in early March when prospects of a no-deal outcome were seemingly off the table.
There is a 30 per cent chance that Britain will exit the bloc in October without a divorce agreement, a Bloomberg survey of 13 banks showed in early August. That's more than three times the level from a similar poll in February. In the latest survey, strategists assigned only a 15 per cent probability to the prospect of a deal being struck by the deadline.
Sterling, and not UK bonds, offers the "cleanest" way to trade Brexit risks for BlackRock's Mr Harrison, who has had a short position in the currency for more than two months and is also using option strategies that benefit from an increase in volatility. His central case for the UK-EU split was one where he sees the current deadlock between the two sides persisting.
While the UK currency is likely to jump if a deal passed through the House of Commons, Mr Harrison is sceptical that the path beyond would be far from clear.
"There is a way of threading the needle that provides an upside sterling risk but I would not make that a central case," he said. BLOOMBERG