Sterling weakened despite stronger-than-expected UK GDP growth at the start of the year. Markets are pricing in slower expansion later in the year due to an energy price shock.
Higher UK yields and conditions that support carry trades helped sterling outperform during the Middle East conflict. Despite this, near-term risks have increased because of UK political uncertainty.
A potential Labour leadership contest is being watched, with a survey pointing to a soft-left candidate as the most likely replacement for Keir Starmer if a contest occurs. This has raised concerns about future fiscal policy, which has weighed on UK gilts and sterling.
The article was produced with the help of an AI tool and checked by an editor.
The pound is softening, and we believe this trend will continue despite some initially strong data from early this year. The market is now looking past that, focusing on the inevitable slowdown caused by sustained energy price pressures. This is creating a clear opportunity for traders positioned for sterling weakness.
We are seeing concrete evidence of this slowdown, with first-quarter GDP for 2026 coming in at a sluggish 0.1%, confirming the fears of a stalled economy. Compounding this, the latest inflation figures from April showed CPI remains sticky at 2.8%, well above the Bank of England’s target. This puts the central bank in a difficult position, unable to cut rates to spur growth without fueling inflation.
The political risks once speculated about have now become fiscal realities under the Labour government. The Spring 2026 budget revealed higher-than-expected borrowing needs, pushing 10-year gilt yields up to 4.5% as markets demand a premium. This growing unease over the UK’s fiscal health is putting direct, sustained pressure on the pound.
For derivatives traders, this points towards buying downside protection on sterling. We suggest considering put options on GBP/USD with expirations in the next two to three months to capitalize on the expected decline. The current environment of high uncertainty also means implied volatility is likely to rise, making long volatility strategies like straddles potentially profitable around key data releases.
Looking back, the optimism for a UK recovery that we saw in mid-2025 has clearly evaporated. The favourable carry trade conditions mentioned then are also at risk, as the market begins to price in the possibility of rate cuts later this year to combat the economic slowdown. An unwinding of these carry trades would only accelerate the pound’s descent.
