Sterling edges up; pre-budget jitters stoke volatility

By Ozan Ergenay

London (Reuters) -Sterling headed for a fourth daily rise on Tuesday, while traders piled into the options market seeking protection against heightened volatility in light of Britain's upcoming budget announcement. 

The pound, which is heading for a 4.8% gain this year, last traded at $1.3132, up 0.24% on the day, while edging up against the euro, which dipped 0.1% to 87.815 pence.

Reflecting the nervousness over how sterling might react to the budget, the cost of hedging against a large overnight swing in the price has shot to its highest in months.

Overnight sterling implied options volatility, a measure of demand to own derivatives to protect against turbulent price action, shot to nearly 12% on Tuesday, from below 2% at the start of the week, according to LSEG data.

At one point, overnight implied vol for euro/sterling hit its highest since the market turmoil in April, after U.S. President Donald Trump's announcement of sweeping global tariffs. 

Francesco Pesole, currency analyst at ING, noted that one-week implied vol for euro/sterling was well above where realised volatility - how much a currency pair is actually moving - and that gap was at the highest since the 2022 mini-budget crisis.

"This signals that, despite some recovery in back-end gilts, the currency market remains concerned ahead of tomorrow's UK budget announcement," he said in a note to clients. 

Finance Minister Rachel Reeves will announce her long-awaited budget on Wednesday and is expected to need to raise tens of billions of pounds to stay on track to meet her pre-election promises and fiscal targets.

Sophie Svestad, communications manager at Ninety One, said Reeves faced a difficult balancing act, by attempting to deliver a budget that simultaneously pleased Labour backbenchers, the electorate and the gilt market.

"To try to achieve this we are likely to see an end to the two-child benefit cap and little in the way of new spending cuts," Svestad added. 

(Reporting by Ozan Ergenay; Editing by Amanda Cooper and Alex Richardson)