What to Watch: Pound Bets Weighed Before BOE, U.K. Budget, Wages

Pound downside, volatility pickup eyed by some analysts
Photographer: Chris Ratcliffe/Bloomberg

It’s a big week for the pound, as the U.K. budget, wages and employment data, and a Bank of England rate decision bring investor focus back to domestic factors.

January employment and wages data are due at 9:30 a.m. in London on Wednesday. The three-month jobless rate is expected to be unchanged at 5.1 percent, while gains in average weekly earnings are forecast at 2.0 percent versus 1.9 percent previously.

Chancellor of the Exchequer George Osborne will present the budget from 12:30 p.m. on Wednesday. He warned last month that he may make further cuts in public spending.

The BOE rate decision is due at 12 p.m. in London on Thursday. All 43 analysts surveyed by Bloomberg expect the bank rate to remain unchanged at 0.5 percent.

Here’s what analysts see as the main drivers for the pound this week, and how to trade them:

What will drive the pound this week?

The budget announcement is an important downside risk for the pound, given the likely confirmation of aggressive fiscal tightening, according to Barclays analysts.

BNP Paribas sees the sterling gaining should U.K. macroeconomic data improve, while expecting the BOE to leave policy unchanged.

Commonwealth Bank of Australia says the pound may garner some support from the jobs data. That said, the risks are tilted to the BOE minutes sounding more cautious, given the slowdown in the U.K. growth momentum, low inflation and rising risks around the European Union membership referendum on June 23.

How do investors trade pound risk events?

The trade of the week at Barclays is to buy pound volatility ahead of the referendum, as the implied volatility between now and the vote is seen as too low. Barclays recommends buying 25 delta sterling-dollar puts with strike at 1.3768, for investors with the view that volatility is likely to increase and the pound will depreciate in the next three months.

BNP Paribas says short-pound positioning is still extreme, implying the currency could appreciate significantly if macroeconomic news improves.

Meanwhile, CBA says the U.K.-U.S. two-year swap spread looks set to become more negative, pointing to further sterling declines versus the dollar.

Morgan Stanley analysts say selling the pound versus the greenback at market, to target 1.3500 and with stop at 1.4560, is the best way to express a bearish call on the U.K. currency. The main risk to the trade would be if higher commodity prices and stronger U.K. equity markets support the sterling this week. The pound remains vulnerable to any stock sell off and higher volatility, as financial services form a large part of the economy, the analysts add.

Bank of Montreal analysts prefer to sell sterling on rallies into Wednesday’s budget, and favor the 1.4375 to 1.4410 range versus the dollar, with stops at 1.4450. They see a possible dip in cable below 1.4300 soon. The euro-sterling cross also offers good longs in the 0.7700-0.7750 area, even as euro long-covering may have further to run following last week’s price action.

ING says the pound could drop toward the 1.4170-1.4180 area by the end of the week. The bank’s strategists see a good opportunity to sell sterling this week amid a more buoyant external environment, as the run-up to the EU referendum is likely to be tumultuous.

How significant is 'Brexit' risk at this stage?

UniCredit strategists say the jobs data and the BOE decision are unlikely to move the currency this week, and the EU referendum remains the biggest risk to U.K. financial stability. The decline in sterling implied option volatility is due to an improvement in risk sentiment, and not because of fading worries over a possible U.K. exit from the EU. There’s still scope for a further drag on the currency in the run-up to the vote, the strategists add.

Thursday’s EU summit in Brussels, where migration is likely to be a key focus, may have an important bearing on the pound and voter sentiment in the context of the EU referendum, according to Barclays.

Morgan Stanley analysts say weakness in U.K. services purchasing managers index readings indicates “Brexit” worries and volatility are going to take a toll on the economy. Markets will continue to monitor referendum polls, but so far they’ve had little impact on the currency, the analysts add.

The risk of a U.K. exit slipped off the market’s radar in recent weeks because of the European Central Bank decision and general risk-on sentiment, Bank of Montreal analysts say. In reality, however, odds have moved materially against “Brexit,” they add.

Meanwhile, ING analysts say the “Brexit” debate will not be far off the agenda this week and noise surrounding the EU referendum could pick up again.

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