The pound is buckling under concerns about Brexit, and the Bank of England may add further pressure to the currency when it meets this week.
Sterling dropped as much as 0.8 per cent against the dollar to 1.2119 on Tuesday, and was set for its worst slide in almost three years. The cost of insuring against volatility in the pound over a three-month period has climbed to the highest among the Group-of-10 currencies as concerns grow that UK Prime Minister Boris Johnson will opt for a no-deal Brexit.
The central bank is also expected to signal that it is unlikely to raise interest rates in coming months, removing any support for the currency, which is trading at about the lowest since March 2017.
Money markets are pricing a more than 60 per cent chance of a 25-basis point rate cut by December on concern the UK may exit the European Union without a divorce deal. That compares with only 20 per cent in June, shortly after the central bank bucked global trends and cited the need to raise rates in coming years.
"With Boris Johnson now installed as PM, the Brexit saga is set to recommence," strategists at JP Morgan, including Meera Chandan, wrote in a client note. "The BOE's shift toward a neutral bias – all but giving up hopes for continued normalisation – will do little to support" the currency.
JP Morgan sees policymakers lowering their growth outlook while moving further away from raising rates when they announce their decision and release their quarterly inflation report on Thursday.
Three-month risk reversals for the pair slipped to 185 basis points in favour of selling sterling, the most bearish since April. The pound also fell against the euro and the yen.
Gilts, meanwhile, are headed for a third monthly rally and strategists foresee the gains extending. The yield on 10-year government bonds has fallen 19 basis points to 0.64 per cent this month, and could slip below 0.50 per cent in the event of a no-deal Brexit, according to Petr Krpata, the chief Emea currency and rates strategist at ING Bank NV.
"The more Brexit uncertainty there is, and more it spills over negatively in the growth outlook, the more downward pressure on UK yields there will be," Mr Krpata said. "If early election weighs on sterling, as we expect, then UK rates and yields will go lower due to the mix of flight to safety and the Brexit uncertainty."