Sterling plunges to 2018 lows as Brexit unease builds

LONDON (Reuters) - The pound was engulfed in a heavy selloff on Wednesday, skidding to its lowest levels against the dollar and euro in almost a year as markets ramped up bets on Britain leaving the EU without an agreement with Brussels.

London-based traders reported a significant increase in investor hedging against a possible freefall in sterling in the event of a 'no-deal' Brexit, which could damage the economy by raising trade barriers with the UK's biggest export market.

The exodus began after UK trade minister Liam Fox said on Sunday there was up to a 60 percent chance the country could leave the European Union next March without any new trade deals in place. The currency move has snowballed since.

There was no obvious trigger for Wednesday's big moves lower, but rather a building sense of investor anxiety as the clock ticks down towards a series of EU-Britain meetings starting in September with no agreement in sight.

"What we are seeing is broad sterling weakness, a very aggressive weakening trend," said Peter Kinsella, strategist at Commonwealth Bank of Australia.

Sterling tumbled against the euro (EURGBP=D3), dollar

The slide against the euro, the biggest one-day fall since end-May, left the pound below 90 pence for the first time in nine months.

Three-month sterling implied volatility, a gauge of expected swings in a currency, surged to its highest since March

Part of the hedging trade was being driven by companies.

"A lot of companies can't wait for the (Brexit) negotiations outcome in October, so of course are trying to hedge against a drop in the pound," said Christophe Barraud, an economist at Paris-based brokerage Market Securities.

Sterling slumped 0.6 percent versus the euro to 90.175 pence. The pound fell to as low as $1.2859 against the dollar.

NO RATES RESCUE

Analysts said the pound was also being hit by a growing realization that, after last week's Bank of England's policy meeting, UK interest rate increases were likely to be as limited as one a year and contingent on a smooth Brexit.

The BoE raised rates from crisis-era lows last week, but few investors saw the increase as a vote of confidence in the economy with so much political uncertainty ahead.

"Some are thinking in the market that the BoE raised in order to given them ammunition to cut rates in the face of a 'no deal'," said Neil Jones, head of hedge fund FX sales at Mizuho Bank. "The next move could be a cut rather than another hike."

Options markets supported the idea that there would be little relief in the coming months for sterling.

Risk reversals - used commonly to hedge against expected currency moves - in sterling/dollar fell to their lowest since early March 2017. That indicates a sharp rise in demand for sterling "puts", or options to sell the currency.

"BREXIT MESS"

British Prime Minister Theresa May will discuss Brexit with the EU's 27 other leaders at an informal summit in Austria next month and meet with them again in October to try to seal deals on the terms of Britain's withdrawal.

“We remain bearish on the pound in the short term until the Brexit mess is out the way," said Nomura strategist Jordan Rochester, predicting a range of $1.27-$1.28 before September.

The pound has fallen 10.6 percent since mid-April versus the greenback and is down almost 5 percent year-to-date.

Traders are also preparing for Friday's reading of second-quarter British economic growth numbers, which might offer some relief.

There was a silver lining on Wednesday for equities, with Britain's export-heavy FTSE 100 equity index (FTSE) surging 0.8 percent. The more domestically orientedFTSE 250 index<.FTMC< rose 0.4 percent.