Pound Options Show Traders Bracing for Volatility as BOE Nears

(Bloomberg) -- It’s looking like a busy day for pound traders.

Investors and economists are betting the Bank of England will increase its key rate a quarter point when it meets later Thursday, but decisions in the past 24 hours by the US Federal Reserve and the Swiss National Bank have raised the possibility that an even larger hike could be on the table.

Pound volatility cooled from its peak on Wednesday in the wake of the Fed’s 75 basis-point rate increase, but demand for one-day options to hedge against swings remains high. Options gauges suggest the UK currency could sink below $1.20 if pound bulls are left disappointed by BOE’s decision.

A surprise half-point hike can’t be ruled out, according to You-Na Park-Heger, a currency strategist at Commerzbank. 

“It’s difficult to predict how sterling is going to react,” she said, adding her base case is for a quarter-point hike. “Is it positive for sterling if the BOE is hawkish? Or would this fuel concerns of a hard landing?” 

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Central banks around the world are struggling with the dilemma of taming surging inflation while also managing risks to economic recovery. The UK’s gross domestic product contracted in recent months and could lose more momentum, as workers remain outside the labor market and price pressures constrain businesses.

The pound traded 0.7% lower at $1.2090 as of 9:38 am in London. Money markets are pricing around 34 basis points of tightening Thursday, indicating a quarter-point hike is fully priced with some hedging for a larger increase.

Risk reversals, a barometer of market positioning and sentiment, show bearish wagers dominate as demand for dollar exposure increases with the Fed poised to deliver another big hike at its next meeting. 

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