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History Shows It's Too Early to Start Trading Britain's EU Vote

  • Sterling volatility is lowest among Group-of-10 currencies
  • Exit risks sidelined by markets awaiting referendum date

As David Cameron hammered out his plans to reform Britain’s role in the European Union before a referendum on the nation’s membership, financial markets barely blinked.

That’s because traders are still waiting for one vital piece of the jigsaw: the date of the vote.

The U.K.’s recent major political events -- the general election in May and Scotland’s independence referendum in September 2014 -- have shown traders typically wait until just weeks before the votes to price in a risk premium.

So far, Britain’s prime minster has said only that the referendum will take place before the end of 2017. With no clearer insight than this, volatility on the pound against the dollar -- usually the first place traders’ angst starts to register -- has remained the lowest among the Group-of-10 currencies. That’s even after Cameron’s plans to make EU membership more favorable ran into immediate opposition on Tuesday.

“It’s because we don’t have a date that’s set in stone that, right now, it’s not a no-brainer trade to put on,” said Jordan Rochester, a currency strategist at Nomura International Plc in London. “Markets aren’t always the fastest at deciphering political risk into market premium. There are no clear signals of some sort of strange volatility premium being assigned to a specific date.”

One-year volatility on the pound versus the dollar was little changed at 8.8 percent as of 11:10 a.m. London time, below the almost three-year high of 10.5 percent reached in April.

A YouGov Plc poll last month suggested opinions were evenly split on an EU exit, mirroring surveys before the Scottish referendum and the general election. Before Scotland voted to remain part of the U.K. last year, it took until the beginning of September -- less than three weeks before the vote -- for the volatility to materialize.

‘Volatility Premium’

Concern the U.K. would lose vital export markets if it quits the EU leave the pound vulnerable in the run-up to the referendum, particularly given the size of the nation’s current-account deficit, according to Kamal Sharma, senior G-10 currency strategist at Bank of America Merrill Lynch.

“The first port of call once an announcement is made on the referendum date will be a reaction in the FX options space,” Sharma said from London. “You’re likely to see some risk or volatility premium being built into the curve.”

For now, markets aren’t showing the risks.

Options suggest traders are bullish on the pound’s prospects versus most of its major peers in the next six months. Sterling was at 70.76 pence per euro on Wednesday, near its strongest level versus the shared currency since mid-August amid speculation the Bank of England is moving closer to raising interest rates.

In a speech in London on Tuesday, Cameron outlined four key demands contained in a letter to EU President Donald Tusk and expressed confidence that a deal could be reached. While the EU commission described some elements as feasible, proposals on restricting benefits to migrants from other EU nations were akin to “direct discrimination”, its spokesman Margaritis Schinas said.

Political Risk

Cameron has said that he will campaign to avoid the U.K. exiting the EU if a deal can be reached on reforms. In the meantime, nothing can be ruled out, he said.

“Brexit political risk is likely to be one of the key factors holding the pound from advancing too far in 2016,” Chris Turner, the London-based head of currency strategy at ING Groep NV, wrote in a note to clients.

The bank forecasts sterling will weaken more than 7 percent to $1.40 in the second quarter of 2016.

“So far, there appear few signs in the pound options market that any particular date is being favored for the Brexit referendum,” Turner said. “It is far too early for this to appear.”

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