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The major trend of sterling has been downtrend that has turned into the consolidation phase from the last couple of months, accordingly, we have reserved our judgement about the consequences for GBP of a clear hawkish shift at the BoE and have been open-minded about whether we should position long GBP for the initial policy action, or short GBP for the possibility that the MPC could be about to commit a policy mistake.
As we detailed last week, UK rate expectations are appropriate from the perspective of inflation or the output gap, but conspicuously overblown when benchmarked to current UK growth. The BoE has not been much help in coming to a strategy conclusion as the explanations it has offered for soon tightening policy are unconvincing and inconsistent (inflation risks are being simultaneously attributed to a strengthening in actual growth and a decline in potential growth). But with the UK curve pricing what is tantamount to a normal hiking cycle of approximately 100bp (refer above chart), and the economy showing no overall sign of accelerating from a 1.0-1.25% growth rate, we’re inclined to believe that UK rate pricing has peaked for now, so too GBP.
Sterling was bedevilled by growing political uncertainties in the UK after Theresa May failed to shore up her position in the Conservative party conference, plus the EU Parliament declaring a lack of “sufficient progress” in the Brexit negotiations.
However, it is not sufficiently convinced of this to warrant a cash short in GBP; instead, we prefer to express a view of bounded pressure on GBP through a call spread with the upper strike marginally below the recent peak. Contemplating all these factors, accordingly, we’ve formulated below options strategy.
We encourage a pre-emptive long in EURGBP via a call spread as the UK curve prices close to a normal rate hike cycle which may look excessive if the MPC delivers a dovish hike in November and growth languishes near 1%.
As shown in the above diagram, buy a 2-month 0.8850-0.9150 EURGBP call spread at the net delta of 0.34 for 52bp. Spot reference 0.8939:
Currency Strength Index: FxWirePro's hourly EUR spot index has shown 142 (which is highly bullish), while hourly GBP spot index was at 73 (bullish) at 12:30 GMT. For more details on the index, please refer below weblink:
http://www.fxwirepro.com/currencyindex.
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