'Peak pound' may be over as multiple risks mount for UK markets

While war-time economic data is still limited, British inflation rose to 3.3% in March, and higher prices are expected to weigh on growth. And polling suggests Starmer's Labour Party may face a rout when a number of local authorities hold elections on May 7.

The pound's ​recent strong run against other major currencies during the Iran war is losing steam, as a combination of ​political, economic and inflation risks mount for UK markets. Sterling emerged as a surprise ‌European ​outperformer in March, and has strengthened around 2.1% against the U.S. dollar and roughly 0.8% against the euro in April.

But the scandal around Prime Minister Keir Starmer appointing Peter Mandelson, who was linked to the late convicted U.S. sex offender Jeffrey Epstein, as ambassador to the U.S. does not appear to be subsiding. At the same time, Britain's economy is ‌struggling, not least because of the conflict in the Middle East that has driven energy prices higher. While war-time economic data is still limited, British inflation rose to 3.3% in March, and higher prices are expected to weigh on growth.

And polling suggests Starmer's Labour Party may face a rout when a number of local authorities hold elections on May 7. LEADERSHIP CHALLENGE COULD HIT POUND, ANALYST SAYS

The options market shows traders are more nervous about election week. Two-week implied volatility, a measure of demand ‌to hedge against large swings in the pound, is around 6.5%, according to LSEG data, compared with 6.1% for one-week implied volatility and 6.4% for one-month implied vol . “I think there is definitely this event risk with the elections, ‌and this always invites either instability in politics or fiscal risks. And I think in our estimates and forecasts, that implies a bit of softness for the pound into May," Barclays currency strategist Lefteris Farmakis said.

One market concern is the durability of Starmer's leadership. "I think if we did see the leadership challenge, I think the market would at least initially see that as a reason to sell the pound," Lee Hardman, senior currency analyst at MUFG, said.

MARKETS MINDFUL OF LURCH TO THE LEFT When Starmer's position was questioned in early February as the Mandelson scandal gained traction, weekly data ⁠from the U.S. market ​regulator shows speculators were adding short positions - those that are ⁠based on a drop in value - in the pound.

Starmer sacked him in September after emails revealed the depth of Mandelson's ties with Epstein. British police arrested Mandelson in February on suspicion of misconduct in public office. He was released on bail and has not been charged. He has not ⁠commented publicly on the allegations. He does not face allegations of sexual misconduct. Speculators had held bullish positions in the pound for the first 18 months of Starmer's term, but that conviction began to crumble heading into the end of 2025.

The succession question especially plays a ​significant role, with markets fearful of more left-leaning candidates. Concerns about looser fiscal policy could for example cause market jitters due to the UK's already difficult public finance position. Markets worry that higher borrowing could trigger another surge in ⁠public debt, and have been highly sensitive to fiscal policy shifts since the 2022 "mini-budget" crisis, which saw massive gilt market turmoil.

"Will it be somebody from the more left-wing part of the Labour Party? And that's something that neither money markets in the UK, nor bond markets, nor sterling, would welcome ⁠very much," ​Sandra Horsfield, economist at Investec, said. Traders on prediction site Polymarket were last attaching a 17% chance of Starmer stepping down in May, down from a peak of 38% on April 17 and down from 34% a week ago.

Starmer has said he will lead the party into the next election, which is due to take place by mid-2029. LINGERING WAR RISKS

One of the biggest tailwinds for the pound has been the rapid repricing of interest rate expectations. The Bank ⁠of England had been expected to deliver at least one cut this year to combat a flat-lining economy, but that has flipped to an expectation for two hikes. The shift in rate expectations and a sharp rise in British government bond ⁠yields have served as a catalyst for sterling strength, in ⁠spite of the energy shock from the war.

However, as the conflict has hit a stalemate, yields have somewhat pulled back - and taken some of their support for the pound with them, MUFG's Hardman said, noting that there could also be further war-related fallout. "We'd still expect eventually to see more of a negative impact, not just on the UK economy, ‌but on the pound as well from ‌these higher energy prices having negative spillover impact on the economy, growth, inflation, and also on the pound itself," he said.

(Reporting ​by Sophie Kiderlin; Editing by Amanda Cooper and Alison Williams)