LONDON: Sterling sank more than 1 percent against the dollar on Tuesday, hit by worries over the political fallout from last week's budget and fears that explosions in Brussels will boost the campaign to take Britain out of the European Union.
Bookmakers' odds on Britain choosing to leave the EU in a referendum on June 23 have tightened this week on the back of the resignation of a senior pro-'Brexit' minister and subsequent criticism of Chancellor George Osborne and his 2016/17 budget.
Factoring in Tuesday's attacks in Brussels, betting website Betfair's odds now show a 36 percent chance of Britain leaving the EU, up from 33 percent. Others showed odds of 6-4 or 40 percent.
With investors opting for the traditional security of the dollar over the euro and other currencies, sterling fell 1.1 percent to $1.4205.
"Things were not shaping up well for sterling at all yesterday because of the political tension in the Conservative Party over the weekend," said Stephen Gallo, European Head of FX Strategy at Canadian bank BMO in London.
"The attacks in Brussels certainly will not help. Terrorism is one of the things that we have said might flip the polls either way."
Thirty-four people were killed in attacks on Brussels airport and a rush-hour metro train in the Belgian capital on Tuesday, according to public broadcaster VRT, triggering security alerts across Europe and bringing some cross-border traffic to a halt.
In Britain, a warning from ratings agency Moody's on the outlook for the country's public finances added to concerns about the budget, attacked over the weekend by members of the ruling Conservatives for its "unfair" cuts to welfare.
Official data on Tuesday also showed Osborne was on the verge of missing his target for cutting the budget deficit in the current financial year.
Consumer inflation numbers offered the pound no support, coming in slightly below forecast and still nailed close to zero in both annual and monthly terms.
"Initially sterling was under pressure from the risk aversion due to the explosions in Brussels," said Credit Agricole strategist Manuel Oliveri.
"There was also the argument that terrorist attacks in Europe will make a Brexit more likely. I think that is going a bit far, and in general we think sterling should bottom out around these levels."
More broadly, the pound has recovered since reaching $1.38 after the June 23 referendum date was announced last month. But while a big speculative push against the currency has so far failed to materialise, bankers say the issue is being much discussed both by corporate and fund investors.
They worry that leaving the EU would hit growth and threaten the huge foreign investment flows Britain needs to fund its current account deficit, one of the biggest in the developed world at about 4 percent of national output.
A poll last week showing the "Out" campaign inching in front also led to a sharp dip in the pound, while options contracts allowing investors to hedge against sharp moves in the pound are back near levels seen in the run-up to last year's national election.
"For us it is the FX options that are interesting. We think even now the options market is underpricing the risk reward on the event," said Sugandh Mittal, partner at London-based hedge fund North Asset Management.
"It's not that we're necessarily expecting a 'Brexit', but we see that there's a greater chance than what's priced in."
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