Bank of America said it has closed out a short position in EUR/GBP that it established in May, booking a 0.60% gain in euros as the exchange rate neared the 0.86 level. The strategists responsible for the trade told clients the position had been implemented using a three-month zero-premium risk reversal and was predicated on the view that volatility-adjusted skew had moved to what they regarded as excessive levels.
The bank said it decided to unwind the position because the outlook for near-term returns no longer justified remaining exposed, citing immediate political uncertainty in the U.K. as a key reason for the change in calculation. "Top of mind is the choice of a new Chancellor, which has yet to be decided. Risk/reward therefore compels us to close," the strategists led by Kamal Sharma wrote in a note.
Although the short was closed, Bank of America retained a constructive medium-term stance on sterling. The strategists continue to see scope for EUR/GBP to trend lower toward 0.84. They outline several structural factors they believe support a stronger pound over time.
One of the primary factors cited is rising investment flows into the U.K. related to artificial intelligence. In the bank's view, the U.K. has been a substantial beneficiary as investors seek AI opportunities outside the United States. "The incessant bid to U.K. Plc remains a strong motivation to suggest that the U.K. has been a major beneficiary of the search for alternative AI markets outside of the U.S.," the strategists wrote.
Improving bilateral relations between the U.K. and the EU were identified as another potential tailwind for sterling. Bank of America said progress in reducing non-tariff trade barriers could help ease supply constraints and create a meaningful growth premium for the U.K. economy. The strategists described the direction of travel in U.K.-EU relations as positive and indicated it could gather pace.
Monetary policy dynamics are also part of the bank's rationale. Bank of America noted that the Bank of England's patient approach to interest rates has been "rewarded for its pragmatism," specifically referencing the central bank's decision to wait for developments between the U.S. and Iran to play out before adjusting policy. The bank added that its U.K. economists "no longer see the prospects for BoE tightening and with the terms of trade shock receding, this should be growth supportive."
In sum, while near-term political uncertainty prompted the bank to lock in gains and close the specific EUR/GBP short, the strategists continue to regard sterling as poised for further appreciation over a medium-term horizon, supported by AI-related investment, improved trade dynamics with the EU and a stance from the Bank of England that the bank judges to be growth supportive.