Key Takeaways
- Currency traders see a leadership challenge to Keir Starmer this summer as a flashpoint for the pound.
- With three quarters of FTSE 100 revenue earned overseas, currency is an important factor to weigh up for equity investors.
- Strategists think improved economic growth figures could support the pound.
Political and currency risk are once again on the rise after Manchester mayor Andy Burnham confirmed he would try to replace Keir Starmer as UK prime minister if he wins the June 18 Makerfield by-election.
Following the Labour party’s disastrous local election results on May 7, which triggered leadership speculation and another bout of UK political instability, sterling weakened against the dollar before recovering slightly. This followed a strong run for the UK currency since 2025, when the pound rose from USD 1.24 to USD 1.38 at the start of 2026. Over a year, the pound has weakened against the euro from EUR 1.19 to EUR 1.16.
Investors are viewing the Makerfield by-election as a likely flashpoint for the pound, with markets fearful of the prospect of a more fiscally loose left wing government. Overseas investors in UK assets are also wary of yet another change of leadership: Andy Burnham would become the seventh prime minister since the vote to leave the European Union 10 years ago.
“Political risk is now more of a feature than a bug for the UK,” says Nicolò Bragazza, associate portfolio manager at Morningstar Wealth. “That has been the case since Brexit, and the fact there have been so many changes in government has not helped to reduce this kind of political risk.”
The Risk to Sterling From a Labour Leadership Contest
While there is investor unease around a Burnham-led government’s spending plans given the size of the UK’s national debt, Ebury’s head of market strategy Matthew Ryan says markets are still complacent about the risks ahead. The yield on a 10-year gilt has moved back below 5% after the local election spike—having flirted with near-20 year highs—while GBP is trading roughly in line with pre-election levels against the dollar.
Bond and currency markets usually move in lockstep in response to UK political turmoil—such as the minibudget in 2022 and buildup to the Autumn Budget in 2025—and global events such as the US election in 2024 and launch of tariffs by President Donald Trump in spring 2025.
Ryan sees the June 18 Makerfield by-election as a likely flashpoint for sterling.
“We view the upcoming by-election as a fairly significant underpriced risk for sterling, a complacency that perhaps largely reflects the delayed timetable for a possible leadership change, rather than a genuine receding risk in a change in the status quo,” he says.
“Burnham’s clear preference for an expansionary fiscal stance, higher taxation and larger gilt issuance present a downside risk to markets,” he adds.
Last September, Burnham caused concern among bond investors after he said Britain needed to get “beyond being in hock to the bond markets.” However, he has since rowed back on the comments, stating he would stick to the fiscal rules brought in by current chancellor Rachel Reeves to keep the UK’s debt in check—and placate international investors in UK government debt.
Nick Wall, head of FX strategy at J.P. Morgan Asset Management, says that despite the political drama, a new UK prime minister would have little room for maneuver.
“Regardless of who is in power, policymakers are likely to be constrained by high borrowing costs, which would make large unfunded spending packages counterproductive. If the fiscal rule holds, the UK also has one of the more favorable fiscal consolidation trajectories among developed markets,” he says.
What Do Exchange Rates Tell Investors?
- They reflect global economic trends, but also domestic factors such as expected growth, trade balance, and inflation.
- The political risk of investing in a country is also priced in to exchange rates.
- Interest rate expectations and differentials are also factored into currencies. For example, higher relative interest rates can attract overseas investors in a strategy known as a “carry trade.” At 3.75%, UK interest rates are nearly double those of key rates in the eurozone.
Why Do Currency Movements Matter For Investors?
Currency movements are particularly important for investors in the FTSE 100. Roughly 75% of earnings generated by FTSE 100 companies are overseas, according to FTSE Russell research. If the pound weakens against the dollar, the revenue—and dividends— are worth more in GBP terms. Because of this, the FTSE 100 often performs better when the pound depreciates.
By contrast, companies that are net importers of foreign goods benefit when sterling strengthens as foreign goods become cheaper to purchase.
“If you’re investing in the FTSE 100, currency is one of the most important factors,” Jason Borbora-Sheen, portfolio manager at Ninety One, says.
“Because sterling tends to weaken in risk-off environments, the FTSE can act defensively. It has a higher weighting to sectors like energy, materials, and financials, which tend to hold up better in those conditions.
“So even if you think you’re investing domestically, currency exposure is fundamental to your returns.”
Could Better UK GDP Figures Support the GDP/USD Exchange Rate?
Besides the risks presented by a change in leadership, the Iran war continues to weigh on the pound, with any failure to resolve the conflict likely to have negative consequences for the UK economy given its status as an importer of oil, J.P. Morgan Asset Management’s Wall says.
Meanwhile, ING global head of markets Chris Turner says global growth dynamics are another key risk for GBP.
“The pound is a growth sensitive currency,” Turner says. “If, for example, the US AI rally stalls or corrects, then we would expect sterling to underperform.”
The AI boom could also support the pound. ING’s Turner says there are early signs that the UK could be the preferred European location for AI data center build out, which would boost foreign investment.
“A wild card, which seems unlikely today, is that Labour’s shift toward embracing Europe resonates well with the electorate and a more pro-European story sees investors cut underweight UK equity positions and the pound get a lift,” he adds.
A recent IMF upgrade to UK growth forecasts for 2026 from 0.8% to 1% may also provide an unlikely upside surprise, according to Bank of America FX strategist Kamal Sharma.
“GBP, were it not for continued political noise, should be another beneficiary of the resilience in recent data,” Sharma says. “With recent IMF upgrades to growth, and a healthier starting point for UK consumer balance sheets, we think GBP could benefit over the course of the year if political noise abates.”
BofA expects the pound to strengthen against the dollar to USD 1.43 by the end of the year, before rising further to USD 1.51 over the course of 2027.
Much also depends on the Bank of England, which is expected to increase interest rates this year to combat rising inflation.
