One-month cable implied volatility rose and risk reversals moved further in favor of sterling puts last week as the pound weakened against the dollar after reports surfaced of a rift between the U.K. prime minister and chancellor. One-month implied volatility ticked higher to 8.6% on Tuesday, up from around 8% last week. And one-month 25-delta risk reversals also moved further in favor of dollar calls/sterling puts, rising to 0.4 vol by Tuesday in favor of sterling puts from 0.1 vol the previous week. Traders reported some investors were buying out-of-the money sterling calls with strikes in the GBP1.45-1.46 area as risk reversals cheapened the trade. Spot sank as low as GBP1.4090 last week, its lowest since the U.K. election in June, as a rift between Prime Minister Tony Blair and Chancellor Gordon Brown over the U.K. entering the euro appeared to widen over the weekend.
Ian Stannard, a foreign exchange strategist at BNP Paribas in London, said sterling will continue to face pressure versus the dollar. Several factors are contributing, such as the apparent Blair/Brown rift and a decrease in risk aversion, which had spiked following Sept. 11. "Sterling was a beneficiary of flows because of its attractive rates, but now with risk aversion coming down, funds are moving out of U.K. money market safe havens and we're seeing a reversal of those flows," he noted. As for the euro, he said the market is backing Blair. "It is a political decision and if Blair is willing to push for it, there's probably very little Brown can do to stop it," Stannard continued.
