GRAPHIC-Extreme bets against pound may be overdone as Brexit risks smoulder

By Anirban Nag and Jamie McGeever

LONDON, Aug 22 (Reuters) - Market bets against sterling have never been more extreme even though most indicators show Britain weathering Brexit-related uncertainty so far, leaving currency market positioning prone to adjustment that could lead to at least a temporary pound bounce.

The pound has sunk to its lowest level against the dollar in over 30 years since Britain unexpectedly voted in June to leave the European Union, catching investors off guard and paving the way for the first cut in UK interest rates in seven years.

The political uncertainty surrounding Brexit has darkened Britain's economic, business and investment outlook and renewed bond-buying by the Bank of England alongside the rate cut only piled on more pain for sterling.

But while easier monetary policy and relatively benign economic signals for July have seen UK blue-chip and mid-cap stocks and British government bond prices recapture pre-vote highs, sterling has stayed down and sentiment toward the currency has remained gloomy.

Data on Friday from the Commodity Futures Trading Commission showed that net short sterling positions, essentially bets that the currency will weaken, hit a record 94,238 contracts in the week to Aug. 16.

The figure measure bets placed by more speculative market participants such as hedge funds and short-term traders.

A look at previous bouts of extreme short positioning, however, suggests a rebound in the pound's exchange rate could be close at hand.

Seven of eight periods of similarly stretched short pound positions over the last 20 years paved the way for an average rebound of 11 percent in sterling against the dollar.

An appreciation of 11 percent would lift the pound up to around $1.45.

Historical sterling positioning: http://tmsnrt.rs/2bwwgtJ

UK-U.S (Other OTC: UBGXF - news) . 2-year yield spread: http://tmsnrt.rs/2bwxbKP

Sterling/dollar exchange rate: http://tmsnrt.rs/2bwxuFi

Sterling/dollar risk reversals: http://tmsnrt.rs/2boU2Dy

CROWDED BETS

The exception was in 2008. Then, the shift in positioning was accompanied by a 32 percent plunge in sterling/dollar as the collapse of U.S. investment bank Lehman Brothers triggered the global crisis and worldwide demand for dollars.

"Given how crowded the bets against the pound are, there can be a short squeeze which can take sterling to $1.35. Gains above that will be difficult to sustain," said Yujiro Goto, currency strategist at Nomura.

Trends in the derivatives market indicate these bets against the pound are becoming very crowded and a correction looks likely. That could offer the battered currency some relief in coming weeks.

The one-month sterling/dollar risk reversals - which measure the relative cost of options to buy or sell currency - show the least bias for sterling weakness since May this year. This indicates that investors are actually less bearish on the pound than before the Brexit referendum.

Michael Sneyd, macro strategist at BNP Paribas (LSE: 0HB5.L - news) in London, looks not just at the IMM data but broader gauges of market positioning including client exposure, fund positions and risk reversals. All are flagging up the potential for a rebound.

Much of the bad news may already be in sterling's price, Sneyd reckons, and a snap back on valuation grounds following its slide of more than 10 percent since the June 23 referendum cannot be discounted.

But don't bet on it lasting. At the heart of the uncertainty is when the UK government will invoke Article 50 of the EU's Lisbon Treaty, the rule that formally begins UK-EU divorce proceedings. Prime Minister Theresa May has said will not start before the end of this year.

"Positioning is very extreme," Sneyd said. "But it's unlikely that we'll get any fundamental change in the outlook for some time, so those extreme position will stay with us. Probably for months." (editing by John Stonestreet)