Battered sterling sinks 1.7% to more than five-month low vs euro on Brexit fears

LONDON (Reuters) - The pound fell 1.7% to hit a more than five-month low against a rising euro on Thursday, weighed down by fears that the UK-EU trade negotiations may fall apart.

FILE PHOTO: Pound banknotes are seen in this illustration taken January 6, 2020. REUTERS/Dado Ruvic/Illustration/File Photo

After an emergency meeting on Thursday to discuss Britain’s attempt to pass a bill which would overwrite the Brexit Withdrawal Agreement, EU executives said the trust between Brussels and London have been “seriously damaged”.

The pound was last down at 92.26 pence against the euro, its lowest since March 26. Part of the fall was due to the euro rising after the European Central Bank meeting.

Versus the U.S. dollar, sterling fell 1.1% to as low as $1.2856, its weakest since July 28 .

“Distrust between the UK and the EU is on an upward trajectory, which is hardly what you would hope for as you’re coming to a conclusion of the negotiations. The no-deal probabilities are on an upward trajectory as reflected in the valuations of sterling,” said Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets.

“It’s not the end game in terms of the Brexit outcome, but it’s looking increasingly likely that the risk of an unintended breakdown of the discussions and an unintended outcome of a no-deal looks increasingly likely,” Stretch added.

Investors were watching to see if the bill to undercut the Brexit divorce deal would make the EU leave the negotiating table, but it stuck with the talks.

Goldman Sachs analysts said they thought the British government’s moves were intended to extract “concessions on the UK’s ability to diverge from EU regulatory standards while still enjoying zero-tariff/zero-quota access to EU markets” after the transition period ends this year.

Britain left the EU in January, but is now in a transition period during which it has access to EU markets. It was given a year to agree a new trade deal with the EU.

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Goldman Sachs said it expected “the perceived probability of a breakdown in negotiations to escalate over the coming weeks,” but its base case remains a “thin” free trade agreement that steers both sides back from the brink.

Overnight sterling implied volatility rose to 13%, its highest since March 26, when markets were in turmoil because of the coronavirus pandemic. Higher implied vols suggests traders are adding options contracts to protect against unexpected moves in the currency.

Implied volatility gauges for other maturities were also elevated, including the six-month options contracts - comprising the end of the transition period - which stood close to its highest since mid-May.

Graphic: sterling vols sept 10 -

Latest data from the Commodity Futures Trading Commission showed that hedge funds were slightly long the British currency, which could open the door to more declines if those longs were to be unwound.

Graphic: sterling longs sept 10 -

“At 1.30 sterling is hugely over-valued and while a lot of that is down to the dollar, this negative turn in Brexit negotiations is coming also when UK economic data seems to be losing momentum, there is a rise in new COVID cases and tightening of social gathering guidelines,” said Seema Shah, chief strategist at Principal Global Investors.

“Finally there is a cabinet that’s already thinking of fiscal tightening,” Shah said.

Reporting by Olga Cotaga; Additional reporting by Sujata Rao; Editing by Janet Lawrence and Andrew Heavens