Bank of America has shifted to a more defensive stance on the British pound, arguing that a reassessment among investors about the duration and implications of the Middle East conflict is likely to put near-term pressure on sterling.
In its latest FX guidance, the bank recommends selling GBP/USD in the low 1.34s and sets a downside target of 1.30. At the time referenced in the bank's note, GBP/USD was trading at 1.3385.
Strategists led by Kamal Sharma said markets appear to be abandoning the earlier assumption that the conflict would be short-lived. "The 'short-term' conflict narrative has now been replaced with a concern that the conflict is likely to be more protracted," the note said, adding that investors are increasingly moving toward a defensive, risk-off stance.
That change in sentiment matters for sterling because, according to Bank of America, the pound had been relatively resilient during the initial escalation but now faces renewed headwinds. The strategists point to fresh pressure in the UK gilt market combined with political uncertainty ahead of the May elections as factors that are creating additional downward forces on the currency.
The relationship between UK government bond yields and sterling is also shifting, the bank said. It observed that the correlation between gilt yields and the pound is turning negative, a development it links to increasing market concern about fiscal and political risks. With market sentiment on UK fiscal policy described as fragile, Bank of America views the pound as more vulnerable to further declines.
Concurrently, the bank expects the broader macro picture to continue to support the U.S. dollar. While acknowledging that recent dollar appreciation has moderated, Bank of America argued that the fallout from the conflict is not yet fully priced into markets.
Sharma warned that if the conflict endures, the likelihood of more severe disruptions to energy markets would rise non-linearly, citing elevated risk of attacks on critical infrastructure. The strategists added that even if hostilities were to end quickly, they are skeptical that market risk appetite would rebound immediately. Instead, they see continued dollar support and "further potential upside USD asymmetries over the next several months."
The bank noted clear risks to its recommended trade. A rapid resolution of the conflict or a smoother-than-expected result from the U.K.'s May elections - particularly if they occur without a change in leadership - could undercut the bearish view on the pound.
Market implications
- FX markets: A strategic sell recommendation on GBP/USD targeting 1.30 pressures sterling in the near term.
- Fixed income: Negative moves in gilts and a flipping correlation between yields and the currency signal heightened sensitivity to fiscal and political developments.
- Energy markets: The bank flags a rising non-linear risk of energy disruptions if the conflict persists, which in turn supports the dollar.