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British Pound Plummets After Specter of a No-Deal Brexit Returns

(Bloomberg) —

The pound fell after U.K. Prime Minister Boris Johnson ratcheted up the chances of trade negotiations failing with the European Union.

Sterling declined as much as 1% against the dollar to $1.3145, extending its drop to the longest since June, as Johnson prepared to tell the EU he’s willing to let talks fail rather than compromise on what he sees as core Brexit principles.

“It looks that we are only at the beginning of a painful correction lower in the pound,” said Valentin Marinov, head of Group-of-10 foreign-exchange strategy at Credit Agricole SA, who sees the pound dropping to $1.20 in the event of no deal.

The cost of hedging against swings in the pound out to six months is at the highest level since at least July, with the three-month tenor covering the U.S. election as well as Brexit developments.

Investors are refocusing on Brexit with the two sides accepting they need to reach a deal by mid-October in order to pave the way for a smooth exit at the end of the year, when the Brexit transition period ends. A so-called cliff-edge departure could add to the economic strain on the U.K. from the coronavirus.

Talks between the two sides are set to continue this week.

“If you’re a person who really wants to push Brexit through, you might think that Covid-19 provides the kind of perfect camouflage to hide the costs of a no-deal Brexit, because Covid-19 is so damaging,” Stephen King, senior economic adviser at HSBC Holdings Plc, said on Bloomberg Television.

Brexit may also begin to drive up the U.K.’s low interbank borrowing costs. Traders see U.K. money markets as a riskier bet next year due to politics and reduced support from the Bank of England. The central bank’s CCFF program — which supports money markets through buying non-financial commercial paper — has helped push down borrowing costs but is set to end in March.

Just an Excuse

There are signs that traders are using Johnson’s hardball tactics as an excuse to fuel a rout that started last week.

A measure of sentiment for the pound that covers December, when the transition period ends, is little changed near the least bearish since March. And last week, as the currency fell by the most since June, there were technical signs that it may retreat by another 2.5%.

The muted moves in some pound assets suggest that when traders do start to price in a complete breakdown in Brexit talks, there’s scope for further declines in sterling.

Brexit Hedge

JPMorgan Chase & Co. strategists recommend a traditional bond-market hedge against a chaotic Brexit. They suggest selling 10-year Irish debt, which would suffer given Ireland’s close trading relations with the U.K., and buying French bonds instead.

“Our economist’s assessment remains that the chance of no-deal is about a third, but with brinksmanship part of the process it may appear higher than that in coming weeks before agreement is reached,” strategists including Aditya Chordia wrote in a client note.

The pound fell 1% to $1.3146 as of 11:35 a.m. in London. It slid 0.8% to 89.89 pence per euro.

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