The British pound has displayed surprising resilience during the recent wave of geopolitical uncertainty. According to Bank of America, sterling has become the second-best performing currency against the US dollar since the beginning of March, defying expectations amid global market tensions.
This strength may appear unexpected given the economic challenges facing the UK this year. However, Bank of America analysts suggest that the pound’s performance is driven less by fundamental economic strength and more by favorable shifts in the UK’s terms of trade and positioning adjustments in currency markets.
The bank also highlighted a notable change in the behavior of the GBP/USD exchange rate. For nearly two decades, the pair closely tracked Bank of America’s GBP risk-sentiment indicator. This indicator combines several components, including GBP risk premia, foreign exchange volatility, the UK term premium, and interest rate differentials between the UK and the US.
That historical relationship began to break down in mid-2024. Since then, GBP/USD has consistently diverged from underlying GBP risk sentiment, suggesting that traditional drivers of the currency pair have become less influential in recent market conditions.
Analysts noted that the current geopolitical shock has been global rather than UK-specific. As a result, domestic concerns about the UK economy have temporarily faded into the background. Earlier this year, traders often used EUR/GBP as a vehicle to express worries about UK policy uncertainty, but the focus has recently shifted toward broader global risks.
Bank of America identified two key factors supporting the pound. The first is a relatively favorable terms-of-trade shift for the UK compared with other G10 economies, which has triggered a squeeze in currency positioning. According to the bank’s data, the combined movement in terms of trade and positioning explains much of sterling’s recent strength.
The second factor comes from flows into the energy sector. Energy stocks recently recorded their largest net inflows on record, according to Bank of America strategist Michael Hartnett. Because the UK equity market has one of the highest concentrations of energy companies among developed economies, this surge in investment has helped support the pound.
Although the UK still relies heavily on energy imports, its dependence is lower than that of several other major economies, including Japan, the Eurozone, and Sweden. This creates a relatively positive terms-of-trade dynamic for the pound when compared with currencies such as the euro, yen, and Swedish krona.
Bank of America’s research also shows that sterling typically reacts negatively to spikes in market risk. For example, a one standard deviation increase in the VVIX volatility index is associated with an average daily decline of around 5.43 basis points in the GBP trade-weighted index, compared with smaller impacts from FX or bond volatility.
So far, volatility levels have remained relatively subdued, allowing positioning dynamics to dominate currency movements. However, analysts warn that a sudden surge in market volatility could weaken the pound through traditional channels, as sterling is often viewed as a high-beta, pro-cyclical currency.
With geopolitical attention currently focused on the Middle East, UK domestic politics has taken a temporary back seat. That may change soon, however, as local elections scheduled for May approach. Bank of America believes markets may be underestimating the potential return of domestic political uncertainty.
The bank also noted that the two-month maturity in the FX options market now overlaps with the election period, suggesting investors are beginning to factor in potential political risks.
Given these factors, Bank of America recommends hedging the recent rally in the pound, particularly against the euro. Analysts believe that sterling could face downside pressure if volatility rises or if political uncertainty increases ahead of the May elections. At current levels, the bank argues that FX volatility appears relatively inexpensive.
