Sterling Poised for Further Gains on Yield Advantage, UBS Says

The British pound is expected to strengthen in the coming months, supported by a significant yield advantage over the euro and the potential for an unwinding of short positions, according to a Friday note from UBS.

Yield Advantage Drives Outlook

Analysts at the Swiss bank highlight that sterling's primary appeal is its attractive yield, which they note is the highest in Europe aside from the less-liquid Norwegian krone. The pound currently offers a yield approximately 1.5 percentage points higher than the euro, a key factor for investors in the ongoing "search for yield."

UBS also cited several other supportive factors for the currency, including:

• Recent stronger-than-expected UK economic data.
• A gradual fading of the impact from oil prices.
• Market expectations that upcoming fiscal plans will not be disruptive.

EUR/GBP Seen Drifting to 0.84

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Based on these dynamics, UBS expects the EUR/GBP currency pair to drift toward 0.84 before stabilizing around the 0.85 level. The bank has also set 0.85 as its new forecast for September 2027.

This move would be partly driven by the unwinding of "still substantial short positions" in the pound, a process known as short-covering that can accelerate a currency's rise. While UBS is not bearish on the euro, it believes much of the positive news for the single currency—such as fiscal support and an anticipated final European Central Bank rate hike in September—is already priced in.

UK Politics Identified as Key Risk

The primary risk to this forecast is UK politics, according to the note. UBS warned that market sentiment could "reverse quickly" if initial fiscal announcements from Prime Minister Andy Burnham's government ahead of the November budget are viewed as fiscally imprudent.

A stronger-than-expected economic recovery in the Eurozone also poses a challenge to the forecast, with the potential to push the EUR/GBP pair above the 0.86 mark.