Currency traders are spending more money than usual to shield themselves from sudden moves in the British pound as the UK prepares for its Autumn Budget on November 26. The cost of short-term insurance against these swings has jumped to heights not seen in months.
Options contracts covering one week now show traders expect more turbulence ahead. The euro-pound pairing saw the biggest jump, with one-week volatility measures hitting a six-month peak. Protection costs for pound-Swiss franc trades climbed near a four-month high, while pound-dollar hedging reached levels last recorded in early September.
The gap between expected volatility and actual price movements in euro-pound now stands at its widest point since April. This suggests traders are ready to pay extra for near-term coverage.
Bearish bets mount against sterling
Trading patterns over the past month reveal a gloomy outlook for the pound. Records from the Depository Trust & Clearing Corporation show more bets against the currency than for it, in trades involving both the euro and the dollar.
The euro trades picked up speed in recent days. Many traders view this pairing as a simpler way to bet on UK-specific troubles, since dollar trades get tangled up with American economic news and reports.
Wednesday brought data showing UK inflation dropped in October, marking the first decline in seven months. Despite this, money markets increased their expectations for Bank of England rate cuts. For currency traders, this signals that budget worries now matter more than central bank policy.
British markets fell into fresh chaos on Friday as budget rumors sparked concern about the nation’s financial health. Mixed signals about tax policy caused wild swings in government bonds and the pound.
Questions mounted about whether the government can tackle the country’s rising debt while keeping its campaign promises to voters and maintaining support from its own lawmakers.
The 10-year yield rose 14 basis points to 4.58%, while the 30-year yield jumped 16 basis points. The pound dropped 0.5% to $1.3131, though it recovered slightly from an earlier 0.6% fall.
Conflicting headlines fuel uncertainty
Last Friday’s chaos started with conflicting news stories. Government borrowing costs shot up the most since July, and the pound tumbled while the FTSE 100 stock index headed for its worst session since April. Overnight reports said Chancellor of the Exchequer Rachel Reeves planned to drop income tax increases from the budget.
Markets steadied somewhat after Bloomberg News reported that better UK economic forecasts drove the decision.
But yields climbed again when word spread that Reeves might extend the freeze on income-tax thresholds rather than lowering them. This approach would bring less money into government accounts, raising fears about financial stability.
“My fear is that the budget may be based on overly optimistic growth estimates,” said Mohit Kumar, chief economist and strategist for Europe at Jefferies. “We still need to wait and see that measures the chancellor comes up with.”
Not everyone worries about the selloff. Ales Koutny, head of international rates at Vanguard Asset Management Ltd., called the move a “strong overreaction” and expects the budget will calm markets. Fidelity fund manager Mike Riddell plans to keep his long position in gilts.
The bond market swings echoed a July reversal on welfare reform that sparked talk about a possible Reeves departure, making investors uneasy about Britain’s finances.
The recent turmoil stands in sharp contrast to earlier calm. Gilts posted their best month in almost two years during October, helped by expectations of more Bank of England rate cuts.
