Rabobank said sterling and gilts showed little reaction to a speech by UK prime minister-in-waiting Andy Burnham, who could take office as soon as 20 July if no rival emerges by the 17 July deadline. The address focused on devolution and included a commitment to maintain the current Chancellor\u2019s fiscal rules. The bank pointed to continued calm since Burnham won the Makerfield by-election earlier this month, while flagging that the choice of Chancellor would shape interpretations of the government\u2019s fiscal stance and potential funding risks.<\/p>\n\n
The bank\u2019s view is that political uncertainty can weigh on confidence, investment and growth, leaving GBP exposed if gilt markets turn volatile. It also cited latest CFTC data showing a surge in short GBP positions. Rabobank expects EUR\/GBP to edge higher to 0.87 over a 1\u20133 month horizon, arguing that further repricing of Bank of England rate-hike expectations is likely to pressure the pound.<\/p>\n\n
Based on the current outlook, we see the British Pound weakening against the Euro in the coming weeks. Even with assurances of fiscal stability from the incoming prime minister, the political uncertainty is a significant headwind for sterling. We are positioning for the EUR\/GBP exchange rate to grind higher towards the 0.87 level from its current standing around 0.8550.<\/p>\n\n
This view is supported by recent economic data, which suggests a repricing of Bank of England rate expectations is overdue. With UK inflation having recently fallen to 2.1%, slightly below the Eurozone\u2019s 2.5%, the case for the Bank of England to cut rates before the European Central Bank is growing stronger. A narrowing interest rate differential will likely weigh on the pound.<\/p>\n\n
We have noted that speculative traders are already building positions against the pound. The latest data shows net short positions on sterling futures have widened to over $5 billion, indicating a strong bearish sentiment in the market. This buildup of short positions could accelerate any move lower for the currency.<\/p>\n\n
While the UK government bond market, or gilts, is currently stable, we see it as a key vulnerability. We remember the sharp sell-off in both gilts and the pound during the political turmoil of late 2022. Any sign that the new government might loosen the purse strings could easily spook investors and trigger a similar negative reaction.<\/p>\n\n
Given this, we are looking at derivative strategies that would benefit from a gradual rise in the EUR\/GBP pair. Buying EUR\/GBP call options with a three-month expiration offers a way to profit from our target of 0.87. This strategy allows for participation in the upside while limiting downside risk should the political transition prove smoother than expected.<\/p>\n\n\n\n