The GBP continued to weaken post-referendum, with EURGBP traded briefly above 0.86 and GBPUSD trading below 1.30 early in July. GBP has regained some of the losses, but TWI is still 10% weaker than pre-Brexit. EURGBP currently is trading close to 0.8468 and GBPUSD close to 1.32.

Forecasts for this pair is that: 0.86, 0.90 and 0.85 in 1,3 and 12 months.

Background: The growth will slow due to increased uncertainty, negative trade effects and tighter financial conditions. - BoE will respond by an interest rate cut to -0.25%. The policy will remain at this low level to 2019. - The GBP will recover when uncertainty abates and fears of a severe negative economic outcome is reduced.

Watch list: BoE on Thursday will be key, with the inflation report seeing expected effects from Brexit on the real economy. Markets awaits further stimulus, pricing a 90% chance for a 25 bps cut in Bank rate and some looking for more QE. 

Interest rates have fallen post-Brexit, with gov’t bond yields down 30-60bps and 10y Gilts seeing new all-time-lows below 0.70%. 3 months interest rate difference (EURGBP) has raised 4bps last month. GBP 2017 FRAS have fallen 11-15 bps since June 24th, while EUR 2017 FRAS are up 2-3 bps.

OTC outlook and hedging strategy:

Delta risk reversals of EURGBP: From the nutshell showing delta risk reversals of EURGBP, you can probably make out that the pair has been one of the most expensive pairs to be hedged for upside risks as it indicates calls have been relatively costlier over puts.

As it showed the 2nd highest positive values (after USDCAD) which indicate upside risks of spot FX is anticipated and hedging for such risks is relatively more expensive.

Needless to specify, GBP vols have still been flying with sky rocketed pace no matter what both prior and post-Brexit event, but this time these IVs are also owing to BOE’s monetary policy decision, IV skews justify this stance.

Since the implied vols are accelerated in high pace ahead of monetary policy that seems to be conducive for EUR call holders. Hence, we recommend options straps to hedge further upside risks of EURGBP.

Here is how the strategy should resemble, longs in 2 lots of 2M 0.51 delta calls while long in 1 lot of -0.49 delta put option of the same expiry, the hedging portfolio is constructed at net debit with 56% of a net delta.