FX Watch: GBP: What’s the story?

Research evidence excerpt

FX Watch: GBP: What’s the story?

The face of the new Government

UK political news is never far from the headlines and this week’s news that ballots for

leadership contenders closed on the 15th with only Andy Burnham standing, the risks for

protracted contest has been removed. For markets, the Fiscal Rule remains the key

anchor for medium-term views and the identity of the Chancellor has been a hot topic

for markets. The rise in GBP this week came at the same moment as a rally in Gilts,

following reports in the FT that current Home Secretary Shabana Mahmood was the

front-runner to become the new Chancellor under a Burnham Administration.

The new-look Cabinet is expected to be announced early next week. Whilst markets have

reacted positively to the news, we think challenges lay ahead in the run up to the

Autumn Statement, hence our GBP/USD vol structure. We await the contours of the new

Administrations spending plans and will take our lead from the price action in UK fixed

income. Our bias remains for GBP vol to rise into Q4.

Our neutral stance on GBP is highlighted via our analysis of GBP/USD. Static rates-based

model suggests GBP/USD is materially overvalued. However, that specification performs

poorly in recent years. A 500-day rolling framework incorporating UK-US yield spreads,

FX volatility, GBP risk premium and a broad USD factor generate a fair value of roughly

1.33 versus spot at 1.35. Sterling therefore appears only modestly rich, by around 1-2%,

rather than substantially overvalued (Exhibit 6).

Exhibit 1: EUR/GBP: BofA forecasts vs consensus and forwards Exhibit 2: GBP/USD IMM 2yr z-score vs GBP/USD

BofA remains more constructive on GBP than the market and forwards. Cable positioning has been structurally short since 2025t

0.90 4.0 1.40