Pound sinks 1pc vs dollar on threat to Brexit divorce deal

Sterling fell on Monday to a 12-day low against the US dollar and the euro as Brexit talks veered into fresh crisis after Britain threatened to undermine its European Union divorce deal.

By 1015 GMT, the currency was down 1% at $1.3145, its lowest level since Aug. 26, while against the euro, it touched a low of 89.90 pence, reaching the same milestone .

Leveraged funds were slightly long on the British currency, the latest CFTC data showed, suggesting traders could push the currency down even further if those longs were to be unwound.

Britain is reportedly planning new legislation that will override key parts of the Brexit Withdrawal Agreement - a step that, if implemented, could jeopardise the January treaty and cause frictions in Northern Ireland.

Implied volatility gauges spiked in nearly all maturities, with six-month options contracts - which incorporate the end of the transition period - hitting their highest cost since July 2 at 9.7%. Three-month vols rose to 9.9%, their highest since end of May and one-month vols also picked up to their highest since end-June .

Sterling had enjoyed weeks of rallies as the dollar weakened and investors stayed on the sidelines, but as traders return from their summer holidays and the deadline for a post-Brexit trade deal looms, the UK currency is looking more vulnerable.

CHALLENGES AHEAD

As traders return from their summer holidays, sterling's fate could soon worsen, having enjoyed weeks of rallies as the greenback weakened, with investors staying on the sidelines, waiting for a trigger.

Britain formally left the EU in January but is currently trading on the same terms as before its exit during a transition period that runs to the end of this year. London and Brussels have both said October is the deadline for clinching a deal on post-Brexit trading arrangements.

As time slowly runs out, any negative Brexit-related headline prompts traders to sell the pound, already beset by woes such as a deep economic recession caused by the new coronavirus and an above 100% debt-to-GDP ratio.

Another scare is how the British labour market is going to perform once the government's furlough scheme runs out at the end of this month. No extensions are expected and analysts say this could trigger massive waves of unemployment.

British finance minister Rishi Sunak's decision to scrap a tax on house sales - known as Stamp Duty - up to a certain amount until March next year has helped trigger a mini rally in the housing market.

Prices jumped by the most since 2016 in August to hit a record high, mortgage lender Halifax said on Monday, mirroring a report last week from Nationwide, a mortgage provider.

Monday's news on Brexit "is just the cherry on top of the cake" for the beleagured UK currency, said Jordan Rochester, currency analyst at Nomura.

"We've had weeks of pretty negative stories about the UK doubling its fishing quota, which would not be agreed to by the EU. We've got the state aid regimes still not being laid out as well by the UK side. So I think sterling is going to underperform here," he said.

Rochester expects the British pound to continue falling against the euro in coming weeks ahead of an EU summit due in mid-October, forecasting the pound to trade around 92 pence going into the meeting.

"And if we do get an actual announcement of no deal, prepare for a hard Brexit, the pound should continue to weaken, we're talking something like 95 to 98 pence against the euro."