Prepare for the pound to become even more volatile

[LONDON] Traders are bracing for further turbulence in the pound as the risk increases of a chaotic UK exit from the European Union (EU).

A measure of expected swings over the next three months, covering the Oct 31 Brexit deadline, has surged to near the highest this year as Queen Elizabeth II approved Prime Minister Boris Johnson's request to suspend Parliament for almost five weeks. That sets up a battle with lawmakers trying to block no-deal and the currency is likely to react to every political headline.

"The next two weeks in Parliament are likely to be even more brutal," said Jeremy Stretch, head of Group-of-10 currency strategy at Canadian Imperial Bank of Commerce in London. A no-deal Brexit is "firmly back onto the radar, impacting volatility".

Three-month pound-dollar volatility has climbed above 13 per cent, the highest since Jan 7, when no-deal risk was also rising ahead of a parliamentary vote on the Brexit deal. That level is the most among Group-of-10 peers and puts it in the same camp as emerging-market currencies such as the Mexican peso.

Traders and companies that haven't hedged their sterling exposure for the October deadline now face having to pay up in the options market. The relative cost of hedging sterling over three months is at its most expensive in more than three years.

Volatility and hedging costs had collapsed after the last Brexit deadline was extended in April, but this time Mr Johnson is vowing to leave the EU "do or die". This week's trading has seen sterling keep reversing direction.

The pound climbed above US$1.23 Tuesday on optimism after the positive tone struck by European leaders at a Group-of-Seven meeting, before sliding the most in a month towards US$1.21 on Wednesday. The currency could tumble to US$1.10 if the UK leaves the EU without a deal, according to a Bloomberg survey of analysts.

BLOOMBERG