The pound had its worst day in two months on Thursday as traders suddenly awoke to the prospect of a no-deal Brexit.
Sterling plunged as much 1.5% against the dollar as UK Prime Minister Theresa May gambled on getting her plan over the line with just over a week to go before the exit. The European Union told May that she can only have a short extension to delay Brexit if Parliament ratifies the divorce deal in a vote she wants to hold next week.
The political turmoil shows no sign of easing despite the looming departure, with French President Emmanuel Macron saying if May's plan fails to get Parliamentary approval again it would "guide everyone to a hard exit." The pound could slump about 8% from current levels if the UK left the European Union without a deal, according to a Bloomberg survey.
"The possibility of a 'no deal' Brexit has increased," said Calvin Tse, North American head of G-10 foreign-exchange strategy at Citigroup. "Obviously they are likely to scrape something together at the last minute, but the risk remains that we fall over the cliff."
The pound fell 1.2% to $1.3043 at 13:20 in New York, taking losses for the week to more than 1.8%. Two-week implied volatility on sterling, a gauge of expected swings in the currency, surged to head for the highest close since July 2016. Option traders are betting on further losses, while fund managers are seeking help from constitutional experts to assess the potential fallout.
"It would be horrific for sterling, it would drop like a stone," said Jane Foley, head of currency strategy at Rabobank. "We're now a week away, the law as it stands suggests a hard Brexit could happen."
The latest developments have caught market participants by surprise, Foley said. She had put a close to zero chance of no-deal in Bloomberg's survey carried out between February 28 and March 4, but now sees a 40-50% chance. Such a scenario could lead the pound to fall as low as $1.20, according to the survey.
Although market participants still have a net short position overall on the UK currency, asset managers and pension funds had recently been adding to long pound positions versus the euro, according to traders. Now Deutsche Bank AG has closed its short euro-sterling trade recommendation, warning "the risks of a last-minute accident have increased."
Brexit standoff takes UK to edge of no-deal as May seeks delay
The Bank of England said more firms are triggering their no-deal Brexit plans. Stocks exposed to the domestic economy fell, with lenders such as Royal Bank of Scotland Group and home developers such as Persimmon among those leading losses. The uncertainty pushed investors to look for safety in Uk government bonds, which led a rally in European debt.
Both May and opposition leader Jeremy Corbyn are in Brussels to talk to EU leaders as European officials have said their priority is to avert a no-deal exit. Still, market participants aren't taking any chances. Aberdeen Standard Investments is talking to legal experts about how Parliament could stop no deal next week.
"I have never seen so many market participants so unsure about one topic as Brexit this morning," said Luke Hickmore, an investment director at the firm.