Euro calls were being snapped up by market players last week after the Bank of England's inflation forecast fuelled speculation of a U.K. rate cut, driving the single currency higher against sterling. The Old Lady's dovish inflation and growth forecast pushed the euro higher against sterling to GBP0.67 on Thursday from GBP0.57 on Monday. "There is considerable interest in buying euro sterling volatility because sterling weakness is expected to continue," said one official.
Traders said players jumped on short-dated euro calls with strikes around EUR0.70. Maturities were typically set between one week and three months, said one trader, adding a combination of inter-bank dealers and clients were looking to hedge existing positions as well as capture euro upside movement. Implied volatility on the pair rose to 5.6% from 5.25% the week before. "This is a reasonable move for this cross which means implied vol is a lot better bid," said a trader.
Currency strategists agreed there were few signs of sterling recovering against the euro in the short term, "The [Bank of England] inflation report has woken up sterling bears," noted strategists at BNP Paribas in an FX report. "Things would look different if the U.K was in an environment of strong productivity and wage growth," it continued. A strategist at another European house said uncertainty over the U.K.'s interest rate future was weighing heavily on the currency.
