LONDON: Sterling traded marginally lower on Monday after another round of polls showed Thursday's vote on Scottish independence still too close to call, keeping bets for volatility over the next week at its highest in four years.
Economic data releases this week may turn markets briefly away from a debate that threatens to rip the United Kingdom apart and set it on a new political and financial course.
But analysts say the referendum has so dominated recent trading that markets will struggle to react strongly even to a clear signal from the numbers - or Bank of England meeting minutes on Wednesday - in favour of higher rates.
"With the markets long-pound positioning having been cleared according to our analysis, sterling is likely to be relatively stable in the days ahead of this week's referendum," analysts from BNP Paribas said in a note on Monday.
One factor driving the pound lower this month has been the idea that uncertainty generated by a Scots' "Yes" vote would undermine investment and growth and prompt the Bank of England to push back an expected rise in interest rates next year.
Tuesday's reading of consumer inflation, below the bank's 2 percent target in recent months, is unlikely to offer a strong argument for raising borrowing costs soon, but will be watched closely along with retail sales and wage numbers this week.
Doubts over the durability of Britain's economic recovery had been weakening sterling steadily against the resurgent dollar even before a shift in the polls in favour of Alex Salmond's Scottish nationalists earlier this month.
The resulting jerk lower has subsided in the past week, leaving the pound trading steadily between $1.60-$1.63 and around 79-80 pence per euro. It was just 0.1-0.2 percent lower against both on Monday at 79.74 pence and $1.6244 respectively.
"It has become very quiet all of a sudden," said a spot currency dealer with one London-based bank. "I doubt you'll see much movement before the vote now."
HEDGED BETS
The cost of hedging against near-term swings in sterling jumped to its highest since 2010 last week and remained around the same levels on Monday - implying the maximum swing in value over the course of a year at 15.500 percent.
Thursday's vote still carries substantial risks to that pricing, which implies a 3-5 cent fall in sterling from current levels. A number of analysts have said sterling would fall more than that in the event of a "Yes" vote.
An options trader with one North American bank said his pricing for clients on similar option trades maturing when the results are announced on Friday implies volatility peaking much higher than the one-week options, at around 20 percent.
There is also the risk of a sharp recovery for sterling after a "No" vote, he said.
"Even if the Scots vote for independence you'd expect the front-end skew to come lower (on Friday) as the uncertainty over the referendum result is behind us," he said. "If the Scots vote to stay, then there should be an ugly retracement in the skew and front-end vols as GBP puts are suddenly not worth nearly as much to the market as they could have been."
Within a month the options market shows volatility falling back to just over 9 percent. After what is already the roughest month for the pound in more than a year, that is double what it was a month ago.
British government bonds were little changed, lagging a rally in German Bunds and U.S. Treasuries. The 10-year gilt spread over Bunds widened by 2 basis points from late Friday to 147 basis points.
Vatsala Datta, a strategist at RBC, cited the weekend's polls, saying: "When the 'yes' camp was in the lead, gilts were outperforming because of the outlook that the BoE would have to keep rates lower for longer."
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