UPDATE 4-British PM Johnson's "final" Brexit deal stirs sterling rebound

Sterling rebounded from earlier lows on Wednesday as hedge funds covered some of their short bets against the currency after Prime Minister Boris Johnson made a final Brexit offer to the European Union.

The pound had earlier weakened 0.5% to $1.2227 but recouped all its losses after Johnson's speech to his Conservative party's annual conference, and the EU's response, to trade flat at $1.2311. It had hit a four-week low of $1.2205 in the previous session. Versus the euro, the pound was a shade weaker at 88.94 pence.

Johnson said unless the bloc compromised, Britain would leave without a deal at the end of the month. To solve the most contentious issue - the border between British-ruled Northern Ireland and EU member Ireland - Johnson proposed creating an all-island regulatory zone in Ireland to cover all goods.

Though the final offer met with a relatively cool reception from EU officials, President Jean-Claude Juncker said Britain's proposal included some "positive advances" but there were still "some problematic points that will need further work in the coming days". Oliver Harvey, a macro strategist at Deutsche Bank said the British government's position has already moved away from abolishing the backstop altogether in the last few weeks towards a legally operable document.

"If an agreement can be reached with the EU over the next two weeks, the parliamentary obstacles to ratification will be reduced," said Harvey in a client note assigning a 35% probability to a no-deal Brexit at the end of October. Many EU diplomats fear Britain is heading towards leaving the EU without an agreed deal or faces another delay, as they say, Johnson's proposals are not enough to get one by Oct. 31.

Johnson said the further delay was "pointless and expensive". With Brexit just a few weeks away, expected price swings in the pound have edged higher in recent days.

Implied volatility on the pound for one-month maturities has nearly doubled over the last three weeks to more than 11 vol as traders anticipate more volatility for the pound. By comparison, implied volatility for the euro and the yen for similar maturities held around 6 vol.

The pound had jumped above $1.23 on Tuesday on the back of reports the EU was open to considering a time-limited Irish border backstop - a major sticking point in Brexit talks. The currency then gave up most of the gains when the EU denied this. "These days anything below a 1 percent move in the pound is flow-related and nothing else," said Jordan Rochester, a strategist at Nomura based in London.

The British parliament has put roadblocks in Johnson's way - passing a law that requires him to request a delay if he fails to secure an acceptable deal at an EU summit starting on Oct. 17. The law reinforced analysts' belief that Brexit will be delayed for a third time. JP Morgan raised on Tuesday the probability it attaches to a Brexit extension to 85% from 60%. It also saw the probability of a no-deal Brexit at 10%, down from 25%.

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