GBP/USD rebounded after holding above its 31 March low of 1.3159, but the balance of risks remains tilted to the downside. The narrative rests on a wider growth divergence, with the US outlook described as stronger than the UK’s, while UK domestic politics adds uncertainty that is weighing on sterling’s recovery.
In UK politics, Andy Burnham won the Makerfield by-election, which is seen as opening the way for his return to parliament and a possible leadership challenge to Prime Minister Keir Starmer. In rates, the swaps curve continues to price a 25bps Bank of England rise to 4.00% in November. Separately, the Bank held its policy rate at 3.75% for a fourth consecutive meeting, a decision described as widely expected, and the degree of hawkish dissent increased in line with consensus.
Pound’s Bounce Seen as Temporary Amid Fundamental Headwinds
We see the pound’s recent bounce from its May low near 1.2420 as temporary, with risks remaining skewed to the downside for GBP/USD. The currency pair is struggling to maintain any footing above the 1.2500 level. This reflects a stronger US economic outlook compared to the UK’s and an increasingly difficult political environment in Britain.
The fundamental economic data supports a stronger dollar. Recent figures show the US economy grew at an annualized 2.1% in the first quarter of 2026, while the UK’s GDP was nearly flat, growing just 0.1%. With US inflation proving sticky and UK unemployment ticking up to 4.5%, the growth divergence between the two economies is becoming more pronounced.
Political and Monetary Policy Divergence Pressure Sterling
Domestically, the UK’s political backdrop is murky and presents a headwind for sterling. We are watching the Labour government’s internal debates over the next budget, with significant pressure to increase borrowing to fund public services. This raises concerns about the country’s fiscal credibility, which could weigh heavily on the pound.
There is also a clear divergence in monetary policy expectations. The Bank of England’s latest meeting revealed a split vote, with some members favouring a rate cut, leading swaps markets to price in a 50% chance of a cut by September. In contrast, the US Federal Reserve remains hawkish, signaling that rates will stay higher for longer to combat inflation.
Historically, periods of political uncertainty combined with economic underperformance have been toxic for the pound, as seen during the 2022 mini-budget crisis which sent GBP/USD to all-time lows. We believe that put options on GBP/USD, or short-term bearish option structures like put spreads, could be an effective way to position for a potential move lower in the coming weeks. These strategies allow traders to capitalize on downside moves while limiting upfront risk.
