12.05.202601:08 Forex Analysis & Reviews: British Pound: Political Risks and Geopolitical Uncertainty

Last week, the British pound demonstrated limited volatility, trading within a narrow range. The absence of significant domestic economic news shifted focus to the results of local elections.

The heavy defeat of the Labour Party, which lost about 1,500 seats, has brought political risks to the forefront. Pressure is mounting on party leader Keir Starmer. The market is closely monitoring any signs of serious leadership contenders or potential shifts in political direction. A key question is how the market will respond to this political uncertainty: will it continue to view it as a supportive factor (through the closure of short positions and reduced risk premium expectations) or will it begin to price in a more sustainable risk premium?

UK economic growth is on a downward trajectory: GDP stands at 1% year-on-year or 0.1% quarter-on-quarter. The housing market is also showing a noticeable decline. The unexpectedly high PMI figures from April raise questions. There are doubts about the sustainability of this growth, considering the upcoming energy costs for companies. These high figures may reflect panic orders ahead of an expected supply shortage.

The further development of the situation largely depends on energy prices and the situation in the Strait of Hormuz. If the Strait remains closed for several weeks, the Bank of England is likely to raise interest rates at least twice, possibly three times this year. Iran's uncompromising stance, demanding compensation, recognition of control over the Strait of Hormuz, and the lifting of sanctions, combined with Tehran's position deemed unacceptable by Trump, maintains a high degree of uncertainty.

Regarding inflation, the situation could develop in two opposing directions. While the market bets that a peace treaty will indeed be signed, if this does not occur, inflation, according to NIESR forecasts, could reach 5-6% by the end of the year and continue to rise in 2027. It goes without saying that this scenario would lead any economy into a depression, as inflation rises alongside declining consumer demand and falling GDP. Currently, the BoE is oriented toward Scenario B (see previous overview), but events are beginning to develop toward the worst-case scenario, where the Labour Party's defeat in the elections is just another step.

The net short position on the British pound increased by $0.3 billion over the reporting week to -$5.4 billion, with speculative positioning remaining bearish, and the calculated price confidently declining.

Although the pound is holding near levels seen before the conflict in the Middle East, its potential for further growth appears exhausted. A breakthrough in negotiations between the US and Iran could trigger a short-term surge in sentiment and push the pound above its nearest high of 1.3658. However, expecting a strong bullish impulse would be ill-advised. A more likely scenario is that the current high has already been formed, and the pair will begin to turn downward towards 1.3450/70. Further dynamics will be determined by the developments in the Middle East and the possible escalation of the internal political crisis.