UBS Expects Further Sterling Strength on Significant Yield Advantage

The British pound, after stabilizing from a sharp rally in June and July, is expected to strengthen further in the coming months, according to a recent report from UBS. The Swiss bank cites sterling's attractive yield and persistent short positioning as key drivers for potential future gains.

Sterling's Yield Appeal

UBS analysts noted that the pound is underpinned by a confluence of positive factors, including a continued market-wide "chase for yield." The report highlights that sterling offers the highest yield among major European currencies, with the exception of the less liquid Norwegian krone.

• The pound currently holds a yield advantage of approximately 1.5 percentage points over the euro.
• This dynamic is supported by recent robust economic data and the gradual fading of last year's oil price shock.
• UBS believes these factors will encourage the unwinding of large short positions against the currency.

Market Outlook and Forecasts

While UBS is not bearish on the euro, it believes much of the positive news for the single currency is already priced in. This includes expectations for stronger growth fueled by fiscal support and a final European Central Bank rate hike in September, which the bank sees as the end of the current tightening cycle.

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Consequently, UBS projects the EUR/GBP exchange rate will drift towards the 0.84 level before stabilizing near 0.85. The bank has also set 0.85 as its new forecast target for September 2027, anticipating that sterling's yield advantage will deliver stronger total returns for investors.

Political Risks Remain Key

The primary risk to this outlook, according to UBS, is UK politics. Market sentiment could reverse quickly if the new government's initial policy statements are perceived as fiscally adventurous. Investors will be closely watching for details on fiscal packages and funding arrangements, particularly around the November budget when Parliament returns from recess.

Additionally, a stronger-than-expected economic recovery in the eurozone could challenge the forecast, potentially pushing the EUR/GBP exchange rate above the 0.86 mark.