LONDON, Sept 21, 2018 (News Wires) - As negotiations become fraught before Britain's exit from the European Union in March, tensions of a different kind are surfacing on the currency markets -- derivatives activity is rising sharply as investors bet on a weaker sterling. Hopes of progress on a Brexit deal between London and Brussels have fuelled a sterling rebound to nine-week highs; yet the view broadly remains that talks will go down to the wire, setting British assets up for a volatile few months. EU leaders' rejection this week of Prime Minister Theresa May's Brexit plan already knocked the pound on Friday, and many investors warn against banking too much on a positive outcome. Collateral damage to the British economy could be enough to warrant holding a short sterling position even as negotiations get more intense, some investors believe. "We are happy to hold our short pound position against the euro through currency forwards as we think there are a lot of red lines that the EU and the UK have to cross before a deal can be signed," said Kaspar Hense, a portfolio manager at BlueBay Asset Management, which runs $60 billion in funds. The International Monetary Fund warned this week that the Britain's economy would shrink if it departed the EU without a Brexit deal but damage was inevitable no matter what terms it leaves on. UBS calculates the economy would lose 6.9 per cent of output in the event of a "soft" Brexit, rising to a 10 per cent hit should the exit be "hard", without a trade deal in place. Most investors, even those without a firm conviction on the final Brexit outcome or the economic outlook, say they prefer trading sterling via derivatives rather than on the spot foreign exchange market. That's because outstanding short positions on the pound in the futures market are more than $5 billion. Such a large bet makes trading the spot pound very vulnerable to any positive headlines on Brexit negotiations because that could force speculators to exit short bets. Indeed, sterling has rallied by 5 per cent from more than one-year lows hit in mid-August to nearly $1.33 and not far away from a 2018 high of above $1.43 hit in April.
