Sterling slid to its lowest in more than three decades against the dollar on Tuesday, on growing fears that Britain's looming departure from the European Union will hit the economy. Sterling had skidded more than 1 percent on Monday on the back of Prime Minister Theresa May's announcement a day earlier that the formal process to take Britain out of the European Union will start by the end of March.
The nervousness led to a rise in the cost of hedging against sharp swings in the pound in the next three to six months. The cost of hedging sterling exposure against the dollar for six months - which includes March - was at 10.60 percent, the same as the nine-month option. Typically the nine-month currency option is dearer than the six-month one. Sterling extended losses on Tuesday, slipping more than half a percent to $1.2757, its weakest since June 1985. It also hit a three-year low of 87.56 pence per euro, down 0.2 percent on the day. "What is causing particular uncertainty among investors are the strong affirmations of the British government to insist on limiting the freedom of movement," said Esther Reichelt, currency strategist at Commerzbank. "This increases fears of a "hard" Brexit because so far nobody sees a possibility of achieving this without May having to accept notable restrictions when it comes to accessing the (European) single market. That in turn is likely to lead to considerable economic effects and be of notable relevance for the attractiveness of sterling investments."
Many in the market are concerned that Prime Minister May's government will back a "hard Brexit" exit from the European single market, send Britain into a recession and blow out its current account deficit, already among the highest in the developed world. A wider current account gap and slowing foreign investments tend to act as drags on the currency. So far the economy has shown resilience post-referendum, but fears of an economic slowdown will raise the prospect of further easing by the Bank of England in the coming months and weigh on the pound.
On Tuesday, the construction sector purchasing managers' index will be released, a day after data showed factory activity grew at the fastest rate in more than two years last month and suggested manufacturing growth in the third quarter will be the strongest so far this year.
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