LONDON: Sterling skidded lower on Friday and implied volatility surged as markets increasingly priced the risk of Britain breaking away from the European Union at the end of the month without a trade agreement.
Prime Minister Boris Johnson said on Friday that Britain was likely to complete its exit from the EU without a trade deal. Current arrangements will end on Dec. 31 when Britain's Brexit transition period concludes. The British currency fell more than 1% against the dollar to a low of $1.3135, its weakest since Nov. 13, before recovering to $1.3230 after Germany's foreign minister said negotiations may continue beyond a Sunday deadline.
Friday's fall puts the pound on course for a 1.5% drop this week, the worst performance since September. It briefly hit a three-month low against the euro before recovering some of its losses and was last trading at 91.65 pence, down 0.3% on the day.
Jitters were clear on derivatives markets too where implied volatility, an options market gauge of expected price swings, rose. One-week and overnight volatility climbed above 20% to more than eight month highs.
UK bank shares also tumbled as no-deal fears spread, with Barclays, Lloyds and Natwest down more than 4%. The FTSE 250 would slide between 6%-10% and UK bank shares would drop 10%-20% with a no-trade deal Brexit, Morgan Stanley strategists said.
Thu Lan Nguyen, a currency analyst at Commerzbank, said the market may "price in a no-deal in the next few days", averting a serious crash in the pound when the deadline for the trade talks expires. "But it is also possible that the market will hold on to the hope of a last-second agreement and then be surprised by a no-deal, which would lead to major market turbulence," she said.
While banks and bookmakers have slashed the chances of a deal, many investors believe London and Brussels will reach a last-minute agreement and the drops in sterling have not been as sizeable as in the run-up to earlier Brexit deadlines.
Some analysts say the market looks complacent. RBC Capital Markets' Global Head of FX Strategy, Elsa Lignos, said that while the odds of a trade deal being reached in 2020 had nearly halved since early December, a basket of sterling versus the dollar and euro was only down around 1%. She said Brexit fatigue, expectations that the political drama is all part of a "set-up for a 'Christmas miracle'" and the view among some that a no-deal Brexit would not be terrible explained why sterling had not fallen further.